We're at the foothills of the next super cycle
We're at the foothills of the next super cycle
One of the most interesting aspects of this week’s US Federal Reserve interest rate decision is the subtle changes in wording that have made a big difference on market expectations.
The Fed has been doing what every central bank needs to do — maintain credibility in balancing the books and keeping things stable. Its wording has previously been very hawkish, going over and beyond to convince the market that it will fight inflation and bring things back in order.
Yet it now seems like things are falling into place, as we’ve been suggesting since September last year. In this week’s statement the Fed shifted its words and introduced a new pledge that it doesn’t want to over tighten just for the sake of it. This is the pivot we’ve been waiting for, the market will start to see that in coming weeks.
While the lagging Bank of England, European Central Bank and possibly even RBA next week continue to hike, there is a growing sense among central bankers that maybe they are going too far. The Bank of Canada has admitted this. Others will be watching carefully.
Forward indicators like retail sales and PMI gauges are all showing that things are slowing down.
It doesn’t take much for the global economy to wobble, as we saw with Adani this week when its market value has been hammered by a research report making some big claims.
Our baseline view hasn’t changed and we continue to see inflation peaking in 1H23 before central banks pause and then turn their attention to more cuts in the coming years.
But we’ve been thinking outside the box about bigger problems and opportunities that will come in the following years.
Mega trends emerge when nobody is looking
One the biggest problems in the global economy has been inflation post pandemic due to pricing shocks to the system, from a disruption to production activity. As Nassim Taleb put it this week on Bloomberg, going from 100 in Year 1 to 100 in Year 2 is not the same as going from 0 in Year 1 to 200 in Year 2, even though the output of both scenarios is the same.
The shock in production and activity is the reason for inflation rising so much in such a short period of time, but this will soon adjust and settle down. Its probably already happening. As Taleb says, inflationary shocks usually always bring gluts with them.
With that in mind, we need to look forward and see what are the factors likely to drive prices in the future. There’s another shock on the horizon that could be a deflationary impact in the same way that China was deflationary following its economic transformation, which saw it become the world’s factory for goods. The price of goods relative to incomes decreased, which allowed for three decades of lower than average goods inflation.
We believe that the next big deflationary impact driver will be genuine artificial intelligence (AI), particularly to the services economy, as basic tasks start to go through a transformation and businesses seek cost savings wherever they can to protect margins.
Buzzfeed’s decision to sack journalists and replace them with AI is an important lead indicator of what many C suite leaders are sitting in their boardroom and contemplating.
AI is not yet ready to replace the skilled economy, but the pace of expansion and cost advantage is extremely disruptive and deflationary.
When China joined the WTO in 2001, it wasn’t in a position to dominate all advanced manufacturing. Yet today it is the largest and most competitive manufacturer of electric cars, one of the most advanced technologies in the world and one which will have a profound impact on our energy transformation.
With the same forward thinking prism, we need to accept the potential implications of a corporate services culture that can very easily and quickly implement technologies such as OpenAI’s chatGPT. For less than $0.01 per query, chatGPT can process a fairly complex query and provide a response within a few seconds.
Microsoft, the empire built on enterprise and corporate technology sales, has already written a $10bn cheque for a piece of OpenAI.
Today’s AI technology doesn’t always provide the most accurate responses and there is a fair bit of training that needs to take place for tricky situations, but the implications for commercial use, particularly in the “expertise economy” is extremely disruptive.
It’s a trend that we believe could become massively deflationary and offset and short term pricing adjustments working through the global economy.
US 10 year bond yields are down from their peak and now below 3.37%. Despite all the inflationary pressure and talk over the past six months, long term bond yields have failed to rally above their naughties peak. Short term bond yields are now also starting to fall as the market looks through the short term Fed correction.
The bond market is suggesting that inflationary pressures will only be temporary, and there doesn’t seem to be a systemic fear that inflation is here to start as a nuisance for more than a couple of years.
While most of the corporate C suite has been occupied with a war in Europe, short term inflation, skills shortages, lockdowns, and a post pandemic hangover, the real trend of AI has emerged as a significant disruptive factor.
We’ll be monitoring closely.