ArticlesMarket CommentaryDown to the Wire?

Down to the Wire?

man walking down tightrope under dark sky. Photo by Marcelo Moreira:


  1. Home Prices drop like a rock
  2. AI mania in full force
  3. Debt ceiling still at an impasse

There were a flurry of speeches by Fed presidents about the need to be steadfast in reducing inflation, however all of this is overshadowed by the impending debt ceiling debacle. If it is not raised, it’ll be the equivalent of Uncle Sam’s face meeting the fist of economic reality. And as Mike Tyson once said: “Everyone has a plan until they get punched in the mouth.”

Meanwhile, the economic data in the past week has been quite mixed. Retail sales, leading indicators and PMIs, none of them changed the broader economic picture. So what stood out last week?

Home Prices Drop Like a Rock

U.S. home prices in April experienced the largest annual drop in over 11 years. This could have a ripple effect on the economy, particularly on the owner's equivalent rent component of inflation.

Chart: Median existing home prices change from year earlier/WSJ

To recap, the owner's equivalent rent (OER) is a measure of the amount of rent that would have to be paid to substitute a currently owned house as a rental property. It makes up approximately 25% of the Consumer Price Index (CPI). A drop in home prices can lead to a decrease in the OER, as lower home prices often translate to lower rental prices. This, in turn, could lead to a decrease in the CPI. 

Chart: CPI Owner’s Equivalent Rent YoY/FRED

It’s been going up pretty much unabated since the beginning of 2021, reaching the highest rate of change since the 1980s. Any drop in this will have a huge impact on CPI.

And as I have argued before, the Fed has been slow to identify the run up in inflation, and is likely now equally late in identifying the drop in inflation that is likely to follow. What’s more important is that prices aren’t just holding steady but dropping, which means that OER could contribute to deflationary forces in the months to come, never mind hitting the 2% target. Perhaps we go negative? That’s definitely not what the Fed wants to see.

And on top of general price changes, structural changes are afoot that will add to the deflationary forces. AI!

AI Mania in Full Force

The recent rally has added approximately $400 billion to Nvidia Corp.'s market value this year. Nvidia, a leading chipmaker whose semiconductors are used in AI applications, has been at the center of the stock market frenzy around artificial intelligence. 

Investors are eager to see evidence that AI-related demand is translating into substantial revenue to justify the stock gains. Nvidia's stock is already priced at 61 times profits expected over the next 12 months, making it one of the most expensive in the Nasdaq 100. For those that have been burned before on NVDA when it last reached such lofty levels, the debate is on. Is AI the breakthrough that’ll propel the stock above all time highs? Or is it the turning point that will send the stock back to Earth?

Chart: NVDA Stock/Seeking Alpha

Regardless of the price dynamics, the rise of AI itself could potentially replace low to mid-level white-collar jobs, leading to a decrease in service sector costs. It is very unusual for something that has come into the mainstream only 6 months ago to be adopted by large companies, yet we are already seeing announcements of thousands of job cuts due to AI from stalwarts like IBM.

What will this look like 5 years from now? The irony is that AI is now much more likely to disrupt highly creative fields than to replace the more mundane yet dexterous jobs like a barber or a janitor. I never thought that the AI revolution would entail humans being the menial labor to support AI creative endeavors! Is the robot uprising already here?

Debt Ceiling Still at an Impasse

Meanwhile, the U.S. Treasury Secretary Janet Yellen has sent a letter to Congress sounding the alarm that the U.S. might not be able to pay its bills in just over a week, possibly as soon as June 1. President Biden and House Speaker Kevin McCarthy are still fighting over details of a deal with no end in sight.

Back in January, the U.S. hit its debt limit of $31.4 trillion. Since then, the Treasury Department has been juggling the bills, even pausing contributions to government workers' retirement and healthcare funds to keep things afloat until about June.

The whole situation is now an extremely high-stakes game of chicken, with politicians using the debt ceiling as a bargaining chip in bigger budget negotiations. The sad part is that any failure will not only damage the US’ standing, but will introduce massive disruptions in the global economy given the US Dollar’s reserve currency status.

Ivan’s Take

A chaotic transition away from the US Dollar in a world with really no credible alternatives does not bode well for long term global economic stability. Even if things were to “resolve” themselves in the coming days, world governments have already seen enough. The world is slowly transitioning away from the US Dollar.

This is complemented by the balkanization of supply chains that is already happening as a response to the supply chain shocks experienced during the pandemic. The world is becoming a more “decentralized” place with the US slowly stepping out of the unipolar world it has led for the last 70 years.

In a sense, this is a good development. It marks a reversal of the massive economies of scale that kickstarted during the industrial revolution, and continued until the last decade with massive outsourcing of supply chains to low-wage countries. This trend has traditionally favored owners of capital.

As countries have become richer, a larger share of their economies have shifted towards service based industries and away from manufacturing. Add to this the massive productivity enhancements to be gained from AI powered services along with the realization that much knowledge based work could be done from “anywhere”, and we could see a more egalitarian world where economic benefits are distributed more broadly, not just to the owners of capital.

Let’s see what happens come June 1st!

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