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On AI’s Impact On Jobs, Bessent’s Iran Options & More FEMO
AI usage in the workplace is starting to become commonplace. As adoption rises, will companies enjoy a productivity heyday and send less productive human workers packing? Melissa looked for early signs of worker displacements by AI, and her findings are encouraging: No labor-market shock looks imminent. … Also: William assesses the geopolitical stakes of a prolonged US/Iran war. The risks include provoking China and sinking Trump’s “grand bargain” trade deal. Needed is a diplomatic off-ramp. … And: With Q2 results in hand for 90% of the S&P 500 companies, Joe shares highlights from aggregate earnings data. Notably, 10 of the 11 S&P 500 sectors grew earnings y/y last quarter, and “Main Street” bested the Mag-6 in earnings beats.
AI-Led Economic Boom Driving Yields Higher In US As Japanese Yields Continue To Normalize
Several factors are driving bond yields higher worldwide (chart). The war in the Middle East in March boosted yields amid concerns that soaring oil prices would revive inflation. The war, along with other geopolitical crises, is bound to increase defense spending and widen already bloated government deficits. Central banks are increasingly pivoting from easing to tightening their monetary policies (chart). As a result, 10-year government bond yields have increased almost everywhere since the start of this year (chart). Japan's bond yield has risen the fastest among developed economies, as the Bank of Japan has raised its official interest rate to stop a free-falling yen from boosting inflation. This is forcing carry traders to cover long bond positions worldwide, which they financed with cheap credit raised in Japan. Some fear that this could be the start of a major global financial crisis. We doubt it, but we aren't ignoring this possibility. In the US, new corporate bond issuance rose to a record high of $2.8 trillion over the past 12 months through May (chart). US investment-grade bond issuance reached a record $1.7 trillion over the past 12 months through July, as hyperscalers tapped debt markets to finance the AI buildout. At the same time, governments continue to run large fiscal deficits, with the IMF projecting global public debt will reach 100% of GDP by 2029. The result is growing competition for capital. In our view, some of the recent rise in US bond yields reflects the economy's strength. We are sticking with our view that the 10-year US Treasury yield should range between 4.00% and 5.00%, which is, in effect, a vote of confidence in the US economy! We reject the popular notion that interest rates will stay "higher for longer." We think they will remain "normal for longer." Current interest rates reflect a healthy economy. Now consider the following related developments: (1) Capital flows. Foreign investors are increasingly favoring US corporate bonds over Treasuries. Private purchases of corporate bonds now exceed purchases of Treasury securities, reflecting strong demand for the wave of investment-grade debt issued to finance the AI buildout (chart). Now get this: Over the past 12 months, foreigners purchased a record $919.4 billion in US equities (chart)! The bad news is that they have a tendency to be aggressive buyers just before bear markets! (2) Industrial Production. Today's July industrial production report showed that factory activity is continuing to improve for the second year in a row following its long soft patch from 2022 through 2024 (chart). The details suggest that the AI buildout remains a key driver of industrial growth. Semiconductor output rose 2.4% m/m and computers increased 1.8% (chart). Since ChatGPT's release in late 2022, technology-related industrial production has risen faster than before, reaching record highs (chart). Electric and gas utilities are increasing their output to meet the needs of data centers (chart). Defense spending is providing another tailwind for industrial activity. The Trump administration is seeking to raise defense spending from $1.0 trillion this year to $1.5 trillion next year. Replenishing armaments, along with rapid technological innovation in defense, should fuel continued growth in the industry (chart). (3) Consumer Spending. In addition to strong AI-related capital spending, consumer spending is also boosting economic growth. Redbook same-store retail sales rose 8.0% y/y in the week ended August 14 (chart). While down from 8.3% the prior week as temporary boosts from Prime Day and the World Cup fade, spending growth remains comfortably above 2025's 5.8% full-year average. (4) Job Growth. For the four weeks ended August 1, US private employers added an average of 9,500 jobs per week according to ADP's NER Pulse, the first increase after seven consecutive weekly declines (charts). That translates to monthly job growth of roughly 38,000, which should be enough to keep the unemployment rate near 4.1% given labor-supply constraints from retiring Baby Boomers and a shrinking foreign-born labor force. (5) Import prices. The prices of goods imported from Taiwan and South Korea have soared in recent months (chart). Prices of imports from China, which tended to fall in the past, are inflating again, putting upward pressure on US prices (chart).
The Bond Vigilantes Are Stirring
The US now pays $1 trillion a year in interest on its $40 trillion federal debt. The Fed is waiting to see if inflation will continue to fall on its own. The BOJ is on the verge of more rate hiking. The outlook for oil prices remains uncertain. That has global bond investors pushing up bond yields higher. William discusses why several governments around the world fear for their currencies. … Japan’s PM may retract her opposition to rate hikes, forced by a collapsing yen and rising inflation. … The Japan MSCI’s rally has solid fundamental underpinnings, Toby writes. But yen weakness hurts the performance in dollars. … Central banks have a new crisis-time lender of last resort, the ECB.
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