Today, October 10th, Markets Weekly opened with positive news: the S&P 500 and Nasdaq reached new all-time highs last week, signaling a continued upward trend. This market strength was complemented by a welcome stability in the bond market.
The podcast first delved into the reasons behind this bond market stability, particularly after weeks of relentless yield increases that raised concerns reminiscent of the 1987 market crash. The stability in the 10-year yield was primarily attributed to a very successful 10-year Treasury auction. Key metrics indicated strong investor demand: the yield cleared lower than implied by the "when issued" futures product, the "bid to cover" ratio was strong (high demand relative to the offer), and the "primary dealer take down" was low, meaning private sector investors absorbed most of the debt. This suggests a "soft ceiling" for yields as current levels are attracting significant interest.
Additionally, inflation-protected Treasuries (TIPS), specifically 30-year TIPS, are trading at multi-decade highs with a 3.3% real yield. This product offers a 3.3% coupon plus principal adjustment for CPI inflation, making it an attractive option for wealth preservation, especially if actual inflation surpasses the market-implied breakeven of 2.2%. The speaker also dismissed concerns about CPI manipulation, noting that inflation is a "social construct" and any government adjustments would likely be minor, not fundamentally altering its rough accuracy.
Regarding Federal Reserve policy, the consensus now points to no rate hike in October, but a likely hike in December, with possibly one more to follow on a quarterly cadence. Governor Waller, who previously advocated for "giving disinflation a chance," has reportedly shifted his stance, citing better-than-expected AI build-out, rising oil prices, and persistent tariffs as reasons to withdraw the "insurance cuts" made last year.
The discussion then touched on oil prices, which have stabilized around $100 a barrel amidst geopolitical noise from the Middle East. The speaker emphasized that the U.S. consumes refined products like diesel and gasoline, not crude oil directly. Diesel prices are exceptionally high at $200 a barrel, revealing a critical bottleneck in refining capacity, partly due to Middle Eastern issues and attacks on Russian refineries in the Ukraine war. Despite efforts to lower fuel taxes or secure deals, a diplomatic resolution in the Middle East is seen as crucial to easing energy prices and boosting the stock market. The speaker believes a diplomatic solution is likely before the midterms, ruling out military action due to "mutually assured destruction" concerns.
Secondly, the podcast addressed a recent "scare" in the AI trade. The speaker views AI as a "huge bubble" where enormous capital expenditure (CapEx) is driving memory and chip stocks. However, the critical issue is that the necessary revenue growth to justify these trillions in investment—requiring a tenfold increase in a few years—is not materializing. Factors like decreasing per-token costs despite increased AI usage, and companies like Anthropic experiencing stalled revenue growth and significant losses (reportedly $40 billion last year), highlight this challenge. A recent Financial Times report suggesting Open AI's revenues were lower than expected triggered an immediate and significant sell-off in AI-related stocks, revealing the market's underlying nervousness and sensitivity to perceived overvaluation. While the market later recovered, disputing the report's methodology, the event underscored the fragility of the AI market. An additional constraint mentioned was the U.S.'s insufficient electricity generation capacity to power all the promised data centers, potentially limiting the AI build-out.
In conclusion, the speaker highlighted the bond market's newfound stability and the underlying jitters in the AI sector, urging listeners to monitor Middle Eastern developments for their impact on the global economy, yields, and financial assets.