A Wider Distribution

Not investment advice.

Markets are moving in a skittish, volatile manner because key anchor points are shifting, and trillions of dollars of capital are being forced to adjust. Specifically, interest rates are moving above what investors thought was possible, and AI demand is moving below what investors thought was possible, despite hopes the bond sell-off was over and that tech stocks had merely wobbled.

Here are the salient points:

1. U.S. growth is not slowing (yet) because what I have referred to as the “cage fight for capital” (AI capex and U.S. government debt). This is producing fast, concentrated growth and slow, broad-based inflation. The Fed is now well behind the curve. What initially seemed like the removal of “insurance cuts” now looks like a full-fledged tightening. Inflation is stuck above 3 percent. Fed Governor Waller floated raising rates 50 bps at once1, which is appropriate in my view.

2. This inflation impulse is not isolated. The same thing is happening in Japan (though not so much in other countries). Below I show inflation in the U.S. and Japan.

Source for this and subsequent charts: Bloomberg.

This means bond yields need to go higher. The consensus as priced into bond markets is that inflation will settle and fall. The Fed rate is currently at 4% and priced to rise to 4.75%, but a typical tightening cycle with inflation this high would move it closer to 6%. Similarly, in Japan, rates are supposed to top out at 2%, whereas before Japan hit their deflationary depression, a policy rate of 4% was more normal.

3. This inflation has created a meaningful swing in politics. Voters everywhere hate inflation. The Democrats know they cannot be associated with inflation and win the presidency in 2028. Fed officials are not elected, but they still represent “the people” and can see that the public is exasperated by inflation. Policy choices will be shaded toward reducing inflation. That is clearly hawkish monetary policy and will almost certainly slow data center growth, which is largely regulated at a local level.

4. Next week, Anthropic IPOs, and the IPO has been described as “oversubscribed.” The company will likely be cash flow negative for years and tens of billions of shares are eligible for sale on Thursday. If the stock starts to trade down, that’s a sign.

5. Jensen Huang lost his seat at NVDA. There are three key founders at the center of AI demand: Jensen, Elon Musk, and Mark Zuckerberg. Elon and Mark have products that use AI (rockets, cars and social media), but their key product is not AI hardware. Jensen’s product is the thing itself—the chips (really switches) that allow the matrix multiplication that makes AI work. He also used his balance sheet to lever up demand. NVDA total commitments are $530 billion, according to the Wall Street Journal. To put that into perspective, that is about the size of the total Tier 1 Capital of the largest US banks. A typical bank is levered 10 to 1, meaning every dollar of credit sponsors $10 of demand. What will the new leadership do at NVDA? My guess is shut down this lending, which is also bearish demand.

6. Finally, many of the models themselves are incredible, but most of us probably don’t need better models. We can barely keep up with what they already do. For instance, AI is woven into many processes at Kate; we are a small firm with no bureaucracy, and even we can’t incorporate the new models fast enough.

Taken together, it looks like central banks need to tighten significantly to stem the inflationary impulse, even as expectations embedded in stock prices are for a continued boom. In good times, an investor can be long stocks and bonds and make money. Sometimes only one asset works but the combo works. It’s rare that neither stocks nor bonds work, yet that is the environment we appear to be in.

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