The Robust U.S. Economy Powers Through Rate Hikes and Rising Bond Yields AI-driven growth looks resistant to higher borrowing costs, spooking Treasury investors
The U.S. economy keeps powering through inflation, tariffs and higher borrowing costs, defying a run-up in Treasury yields and a Fed rate increase. That has the bond market spooked.
The usual economic brakes aren’t slowing growth, hiring or an AI investment boom that looks to be unstoppable. To some, AI’s potential returns seem so bright that even steep interest rates won’t slow down tech companies’ investments. (…)
Treasurys are facing more competition for investors’ cash from an explosion of bonds issued by companies involved in the AI build-out. Strong economic data are also pushing up yields by stirring speculation that the Fed may have to raise rates even higher than previously expected to cool a potentially overheating economy. (…)
Reinforcing that concern, some economists worry that borrowing costs that continue to climb may do less today to slow the economy than they have in the past, potentially requiring an even bigger Fed response. The AI boom could provide kindling, as more of the benefits could ripple out to other parts of the economy, said Eric Winograd, an economist at AllianceBernstein.
“Everything that gets put into building a data center has to be built somewhere,” Winograd said. “So you get this sort of idea of a filtering through the supply chain, a filtering into other areas of the economy that would broaden the base of expansion.” (…)
On Wednesday, an often overlooked report, S&P’s purchasing-managers’ index, provided the strongest evidence yet the economy could be picking up steam, not merely holding firm.
The report was striking across the board: A gauge of manufacturing activity registered its biggest monthly increase since 2022. A reading of service-sector activity jumped to its highest level since 2021. New orders powered growth in both sectors. (…)
“One-third of U.S. households are headed by someone aged 65 or older,” Yardeni said. “These people aren’t looking for mortgages, they are just enjoying the higher investment returns they’ve been seeing.”
Higher yields don’t only reflect expectations of higher growth. The U.S. government debt burden has soared. Yields have also been closely correlated in recent weeks to oil prices, reflecting worries that higher energy costs could feed into broader inflation.
Investors don’t appear worried the Fed will lose its grip on inflation. The breakeven inflation rate—the bond market’s indicator of the inflation that investors expect—remains modest.
Instead, investors are concerned by just how much the Fed may have to raise interest rates to keep inflation in check—a question compounded by their uncertainty about how its new chairman, Kevin Warsh, will lead the institution. (…)
Predominant bets in interest-rate futures markets show expectations that the Fed may hike rates a full percentage point by the end of 2027.
If inflation is being fueled by a strong economy and not just an energy-supply shock, it could create a big challenge for the Fed, Winograd said.
If you’re the Fed, “you’re really going to have to crush everything that isn’t AI, if AI refuses to slow down,” he said.
You mean, the wealth effect, equity markets?
Greg Ip Tuesday:
An oil-price spike delivers two hits to inflation. The first is quick and obvious: As gasoline and other fuel costs jump, so does total “headline” inflation.
The second is slow and subtle. As costlier fuel works its way into other products and services, “core” inflation, which excludes food and energy, comes under upward pressure.
Those latter “second-round” effects have been largely forgotten about in recent decades because “most of those oil shocks in the last 40 years tended to be fairly short lived,” says Morgan Stanley economist Michael Gapen. For example, roughly 200 days after Russia invaded Ukraine in 2022, oil was $7 below its preinvasion price. When companies don’t expect costlier energy to persist, they don’t try as hard to raise prices.
This spike doesn’t look so short-lived. Roughly 200 days after the U.S. and Israel attacked Iran, oil is $25 above its preinvasion price. With tanker and refinery capacity curtailed, European inventories depleted and the cushion of higher U.S. exports and lower Chinese imports fading, oil prices look vulnerable to more disruptions, Morgan Stanley warns.
PepsiCo to Raise Some Prices After Cuts Failed to Grow Sales
The company is expected to increase the prices on grocery-store-sized bags of chips, including Doritos and Ruffles, which had been cut earlier this year, according to people familiar with the plans. The price increases, which will extend to other brands, including SunChips, are expected to go into effect at the end of this year or early 2027, according to the people, who asked not to be named because they are not authorized to speak publicly.
The prices of certain chips will go up by a low-to-mid single digit percentage, aligned with inflation, a spokesperson for PepsiCo said, adding that the new prices will be lower than where they were prior to the price cut earlier this year. (…)
In February, PepsiCo said it was cutting prices by as much as 15% for key chip brands in a bid to boost sales that had faltered after prices got too high, with some chips topping $7 a bag. But the company saw a 2% decline in revenue in its North American food business and flat volume in its most recent earnings in July. PepsiCo Chief Executive Officer Ramon Laguarta said the consumer was under more strain than expected, due to higher gas prices.
PepsiCo is also raising prices this week on some dips, including extra-large and extra-extra large jars of Tostitos salsa and Fritos canned dips, according to a memo viewed by Bloomberg News. At Dollar General stores, the extra-large Tostitos salsa jars are now priced at $4, up from $3.80, while the extra-extra large jars are now $5.50, up from $4.95. The Fritos canned dips increased to $3.75 from $3.30.
The company is additionally expected to increase prices on some sodas and has warned some retailers of the upcoming price hikes, according to people familiar with the matter. (…)
Other food companies, including Campbell’s Co. and Conagra Brands Inc., have said they are raising prices in the face of a sustained increase in energy and fertilizer costs, as well as tariffs on imports. (…)
EARNINGS WATCH
Analysts Snap Longest Run of US Earnings Upgrades in Five Years
Equity analysts have turned net negative on the outlook for US corporate earnings for the first time in months, reflecting concerns about the effect on profits of inflation and higher interest rates.
More analysts have cut rather than raised their earnings estimates for the first time in 23 weeks, ending what had been the longest run of upgrades since September 2021, according to a Citigroup Inc. index.
“The main drivers of the weakness come from consumers, both staples and discretionaries, materials and financials,” said Stephan Kemper, chief investment officer at BNP Paribas Wealth Management Germany. “I think those revisions can be directly linked to a combination of higher living costs and rising energy prices.” (…)
The big-box retailer reported earnings of $6.75 per share, excluding some items, in the quarter ended Aug. 30, higher than the average of analyst estimates compiled by Bloomberg. Tariff refunds added 15 cents of earnings per share. (…)
The company got $184 million of tariff refunds in the last quarter and has received roughly the same amount for the ongoing period, executives said. The company has primarily used the proceeds to cut prices of products like meat, produce, beverages and home furnishings.
Adjusted comparable sales rose 6.7% for the quarter, better than expectations. (…)
The cheap new AI model taking aim at OpenAI and Anthropic Start-up TypeSafe AI’s ‘Jev’ model promises faster, more efficient AI for developers
A Silicon Valley start-up that released its first product just last week is drawing investment offers at a multibillion-dollar valuation, with promises that its AI tools are more efficient than OpenAI and Anthropic’s.
Founded by former OpenAI researcher Diogo Almeida, TypeSafe AI is pitching its “decision model” Jev as a cheaper alternative to the large language models that power ChatGPT and Claude, for certain tasks.
Jev, aimed almost exclusively at software developers, has drawn intense interest in the tech industry and gone viral on social media since TypeSafe emerged from so-called stealth mode last week. Its launch video on X generated 40mn views in less than a week. (…)
TypeSafe is betting that many routine tasks now handed to expensive general-purpose models can instead be performed by cheaper, more specialised systems. If the idea gains traction, it could put pressure on the business models of frontier AI companies such as OpenAI and Anthropic. (…)
TypeSafe’s pitch is that LLMs, designed for interacting with human beings, are ill-suited for the sort of programmatic, repetitive and high-volume tasks many global businesses are trying to automate using AI. (…)
Jev does not produce sentences, explanations or images, but instead promises fast, cheap decisions within software applications. The “classifying” tasks it can be used for include, for example, deciding whether to approve, block or review a request, routing a support ticket or underwriting insurance or credit risk.
The model is designed for developers to build into the back end of their software, and does not have a consumer-facing interface. (…)
The name Jev is a reference to Jevons paradox, the economic observation that making a resource cheaper or more efficient can ultimately increase its total consumption as new uses emerge. While large language models churn through long chains of reasoning that can consume a lot of computing power, TypeSafe says their model quickly selects from a limited range of possible answers based on a probability calculation. (…)
This in turn brings down the number of “tokens” it burns, reducing the cost.
The company claims each query is about a hundred times cheaper and faster to process than LLMs, charging around 4.2 cents per million tokens compared with LLMs that can cost several dollars per million. (…)
Andrej Karpathy, an OpenAI co-founder recently hired by Anthropic, wrote on X that Jev appeared to have tapped into “latent demand” for models that provide simple, cheap and fast decisions, in an area that has been “underinvested into because of a race to higher intelligence” by the frontier AI model companies. (…)
The AI Build-Out Is Becoming the Biggest Economic Bet in U.S. History
WSJ (via Ritholtz)
Trump’s Fight With the White House Press
(…) the White House press office issued letters to the three outlets, dated Tuesday, accusing them of “trafficking in verifiable falsehoods” and “publishing sensitive or classified information.” One specific article cited was a Politico piece from June, quoting a “senior administration official” pegging the odds of a peace deal with Iran at 80% to 85%.
According to media reports, that unnamed source was Vice President JD Vance. And this wasn’t a leak but an authorized briefing, the Washington Post explains.
“Thank you for joining this press call,” an aide began. “The contents of this call are on background, attributable to a senior administration official.” Oops. Other news outlets, such as the Associated Press, also reported the 80% to 85% estimate. (…)
So, a White House press aide explicitly instructed the attending journalists that the contents of the call were “on background, attributable to a senior administration official,” meaning reporters were barred from using Vance’s actual name.
Despite the call being fully authorized and arranged by the administration, the WH cited the resulting June 12 Politico article as a “threat to national security” and an example of “spreading misinformation” to justify revoking Politico‘s press credentials.
Trump on June 14:
This Great Deal will bring Peace and Security to the whole Region. Many presidents have tried to make Peace with Iran, and all have failed before me. The Leaders of the Region have, for the first time, found a President who can help them achieve real Peace.
Oh, BTW, the price of oil, which closed at $87.71 on June 11, dropped 3.2% to $84.88 on June 12, before sliding further to $76.05 on June 16 all the way down to $68.69 on July 2.
The “Great Deal” collapsed when Trump ended the ceasefire on July 8.
Today, that “Great Deal” could be back, but only in phases (!):
US, Iran Said to Be Exploring Phased Deal to Open Hormuz
US and Iranian negotiators are exploring a phased deal that would see Tehran reopen the Strait of Hormuz and Washington lift its blockade of Iranian ports, according to a person familiar with the discussions.
The two countries — which have both refused to make similar agreements in recent months — were making a push for a breakthrough Thursday on the sidelines of the United Nations General Assembly, the person said, declining to be named discussing private matters. Qatari officials are mediating the negotiations.
A sequenced deal would be similar to the memorandum of understanding that the US and Iran struck in mid-June, which led to a fragile ceasefire that collapsed just weeks later. (…)
Araghchi represented Tehran in the talks and outlined its “firm positions” on reopening Hormuz, according to Iranian state media. Those conditions include the US immediately lifting a naval blockade, unfreezing Iranian assets and ending the war “on all fronts,” according to Iranian reports, an apparent reference to Israel’s campaign against Iran-backed Hezbollah militants in Lebanon.
“We have not closed the Strait of Hormuz,” Pezeshkian said in an interview with Fox News broadcast Thursday evening. “It was open without any legal justification or framework. They attacked us.”
Trump told reporters on Tuesday that US and Iranian officials had spoken in New York amid the flurry of UN meetings. His comments lifted stocks and pushed down oil prices.
The American president has repeatedly said the US and Iran were close to a deal with no results. He’s also threatened Tehran with military escalation multiple times — including a threat to “annihilate” the country earlier this week — without following through. (…)
In the FT:
The Trump administration has said it will not return to the MoU, which was condemned by both Republicans and Democrats, and is instead pushing for a more comprehensive agreement that will cover not only the strait but Tehran’s nuclear programme, according to people familiar with the talks. (…)
Both sides said the conversation was productive, but the Iranians privately said they were not optimistic that the US would stick to any agreement. (…)
Pomp prevails over substance as Donald Trump hosts Xi Jinping
(…) The only news was Xi announcing that China would soon send two giant pandas — named Ping Ping and Fu Shuang — to the Atlanta Zoo, in an example of longstanding panda diplomacy that briefly suffered during the Biden administration when US-China relations plummeted to a four-decade low. (…)
Trump and Xi had a one-on-one meeting before being joined by advisers.
The US president appeared to shorten the meeting to make time to show Xi around the White House, including a tour of his Marine One helicopter and helipad. He also pointed out his new ballroom, which was not finished on time to host the dinner. (…)
At the dinner, Trump presented Xi with a statue of a bald eagle. In his toast, he touted his ballroom again, saying it could host 1,000 people when completed. (…)
“Together, let us write a new chapter in our friendly relations,” said Xi, who was wearing a Mao-era suit for the occasion.
While the outcome of the summit may become clearer on Friday after they spend a final morning together, one of Trump’s biggest accomplishments on Thursday was getting his Chinese guest to laugh. (…)
“For Beijing, the real deliverable of this summit will not be on a factsheet, it is the photos showing the unprecedented pomp and circumstance,” she said.
“There is a real imbalance between the paucity of forward movement on issues the US cares about and the pomp and circumstance . . . Functioning channels of communication between the leaders is a good thing, but this summit mismatch is a lost opportunity for Washington.” (…)