Higher rates, higher oil. So why is growth holding up?

BRIAN HESS: Hi, I'm Brian Hess. 

JACK JANASIEWICZ: I'm Jack Janasiewicz. 

BRIAN HESS: This is Tactical Take. Hi, Jack. Time for another episode. 

JACK JANASIEWICZ: Back at it. Labor Day is done. I think it's the home stretch, officially. 

BRIAN HESS: And there's plenty to talk about this month. Let's start with the Fed. Last week, the Fed hiked rates for the first time since 2023, so it's been three years. The statement and press conference were both probably a little bit more hawkish than most people were expecting, so that was interesting. And we got new dot plot. We got a new summary of economic projections. 

Just basically big picture question, what stood out to you amidst all this information from the Fed? 

JACK JANASIEWICZ: Yeah, I think there's three things that I would focus on. One, I think Warsh was a little more hawkish than expected. So it's interesting that everybody that had been asking us about putting Warsh in as Fed Chair and being a yes man for the Trump administration, I think we can put that one to rest, right? 

BRIAN HESS: Not working out that way. 

JACK JANASIEWICZ: Not quite. Not quite as proposed there. But the two other ones I think, one, it's clear that the balance of risks because again, the Fed always has that dual mandate, right, price stability and full employment. The balance of risks has now shifted, in the Fed's eyes, towards inflation. And I think they're pretty comfortable with the labor side of the mandate. So it's almost exclusively an inflation story for them. 

And then the second one, there was a one little liner in there that I think really turned the bond market south, which was removing a dose of accommodation. And that obviously, I think, is what took the market in terms of their narrative. And that's where the hawkish narrative from the press conference came from. 

BRIAN HESS: Yeah, there was a big move in the front end after that press conference. And so now the market's pricing in a much more considerably hawkish path forward. Now, in addition to the Fed, we also had the ECB, European Central Bank, raise rates the week before. And then the Bank of Japan raised rates a day or two later. And both of those central banks also seem to indicate more to come. It's not just the Fed in hawkish mode. 

So now we have a bit of a coordinated global tightening. And those aren't the only three central banks. They just happened to be probably the three most important. But you've got the Bank of England expected to raise rates. The RBA has been hawkish from Australia. So there's lots of central banks changing direction here. Does this worry you, the fact that it's not just an isolated situation with the Fed doing it, but we have rates going up all over the world? 

JACK JANASIEWICZ: Yeah, and it certainly does seem like a coordinated central bank tightening that's going on in the backdrop. But what was interesting, if you go through the commentary from both the ECB and the BOJ, they certainly indicated that there were increased rate hikes coming but at a slow pace. And so I sort of feels like a lot of these central banks know they should be raising rates, but they're not 100% convinced that it needs to happen because they're walking such a fine line in here. 

And as a result, I think the market's OK with that because a slow, gradual tightening, if that's what we continue to see, is something that they can digest. And again, you go around and look at what the market's already priced in for rate hikes, it's somewhere between 3 and 4 through the middle of next year. So a lot of this has already been discounted. So you're meeting expectations, at worst case. 

And maybe best case is the data comes in better than expected on the inflation front. And maybe the market's a little bit too hawkish and then some of those get priced out. So yeah, certainly a global tightening that's in the backdrop, but I would say it's a nice and slow pace. And I think that's what makes the market more comfortable with that backdrop. 

BRIAN HESS: So we can digest it as long as it's well telegraphed and incremental. Now, last month we spent a fair bit of time talking about the rising trend of longer-term yields around the world, which is related to this. And we spent time thinking like, what are the catalysts pushing this higher? Now, that trend continued through mid-September, through where we are today. 

But I guess what I'd like to ask this time around, we've already covered and everyone seems to what's driving it higher, with the front end rising, with the long end rising, with it a global phenomenon, you just mentioned the policy rates don't really concern you because that's being well telegraphed. But what about the long end happening at the same time? Is that a brake on growth? 

I mean, when I look at the US housing data, for example, it's just really stagnant, really dying under the weight of these interest rates. And I'm sure there are other pockets of the economy that feel similarly. 

JACK JANASIEWICZ: Yeah. 

BRIAN HESS: Is this enough to make a difference alongside the policy rates? 

JACK JANASIEWICZ: Yeah, and as our colleague Garrett Nelson likes to say, you can only kill the housing market once. And so I don't how many times he can kill it with the combination of higher mortgage rates and affordability issues. Price is not really coming down. 

BRIAN HESS: True. It's been dead for a while. That's right. 

JACK JANASIEWICZ: Right. And So, I think the story with long-term term yields, one I would say it's interesting because if you look at what the yield curve has done since the FOMC meeting, we've had a little bit of a twist. We've actually had the back-end end rally, so from the tens and seconds that's come in. And you've had the front end push higher. So you've had I guess this twist flattener, if you will. 

So part of that could be just the idea that the market's getting a little bit more comfortable with the credibility sort of coming back. The inflation fighting credentials from the Fed are now back in vogue and getting a little bit more comfort in terms of the longer-term perspective. So maybe at the end of the day, this actually puts a little bit of a ceiling on rates, at least in the interim. And still going to be data dependent, but at least now the Fed has indicated that listen, we're going to be on this, if you will. And that puts that ceiling in rates going forward. 

BRIAN HESS: From a policy standpoint, is anything being done to address the upward pressure on longer-term yields? You just mentioned that central banks are raising rates and that can help. But it's complicated because on the one hand, it does help with the credibility, to the extent that's pushing rates higher, but there's a strong relationship between short-term yields and long-term yields as well. 

JACK JANASIEWICZ: Yeah. 

BRIAN HESS: I'm wondering, how about fiscal authorities? Is anything being done on that front to address this? 

JACK JANASIEWICZ: It doesn't seem like it. And I know Bessant's made some overtures about potentially increasing buybacks at the long end. Again, I just don't think there's enough firepower there to make a difference. The market's probably going to challenge that and probably going to win because they're much bigger at this point. 

But I think at the end of the day, this is very tricky. And I think also complicating the matter on this is that it's the AI CapEx cycle that is really driving a lot of this and increasing the funding costs, and again, if we think about, the ten year at five because let's assume the average borrowing cost for these guys is going to be something along that 10 to 30 year part of the curve. So let's just say 5% borrowing plus a spread for Amazon or Apple, or whoever it is, or the hyperscalers. 

All right, let's say you go from 5 and 1/2 to 6% on financing. I don't think that's enough to stop this cycle because again, we're sort of in that idea there where they're saying, if you're not first, you're last, and they don't want to come in to last. So these incremental moves, I don't think is enough to arrest this backdrop that we're seeing, that's being really exclusively driven by the CapEx cycle.

And unfortunately, raising rates, really, I think, hurts things that are going to be tied to really prime. And prime is going to be really that lower-end consumer because of auto loans, credit card loans, that sort of thing. So maybe we're going to exacerbate the k-shaped economy as a result of this. That's one risk going forward. 

So it's a tricky-- I wouldn't certainly want to be in the Fed's position right now. It's not an easy one.

BRIAN HESS: Exactly. And this was what makes even bond investing tricky right now because you have, like you're saying, reason to hope that with the central banks getting tougher on inflation, that can anchor the long end. But yet at the same time, some of these other sources of pressure on the rates aren't being mitigated. There's nothing being done on the fiscal front as far as we can tell. And a lot of the demand is private sector, where a 5% or 6% borrowing cost isn't enough to dent the appetite to issue debt. 

JACK JANASIEWICZ: Yeah. And it's interesting, I was just, we were just going through the numbers earlier today, when I look at the deficit, the actual government spending side has actually been going down. What's been pushing the deficit higher, though, is just the interest costs that are associated with that. So again, at the margin, we're seeing a little bit less spending, but the cost of that spending and the cost of that borrowing is what's pushing, pushing against that.

BRIAN HESS: That's becoming a bigger and bigger part of the budget. 

JACK JANASIEWICZ: Exactly. 

BRIAN HESS: Which will become an issue at some point. 

JACK JANASIEWICZ: Yeah. 

BRIAN HESS: So yeah, lots of crosscurrents in the bond market. Now mentioned the k-shaped economy and the pressure on lower income consumers while we had oil prices spike again since the last time we chatted. And while I certainly know that matters a lot to those on tough end of the k-shaped economy, does it matter for growth overall? Because it just doesn't seem to have dented growth at all this year. 

I mean, oil prices surged earlier in the year, and then they came off a little bit, but they've been much higher than 2025 levels all year. Yet the economy just continues ripping higher. So I'm curious how important do you think oil prices are to the growth trajectory? 

JACK JANASIEWICZ: I think they help at the margin or hurt at the margin, however you want to frame it. I think a lot of what we're seeing right now from higher oil prices are bleeding through specific pockets of the marketplace. You're seeing it a little bit in food prices, but really the most sensitive sector would probably be airlines. And you can see airfare, the one line item within the Inflation basket, that's been a headache for quite some time. 

So there's certainly there's certain areas that we can see within the inflation basket that you're getting that first and second order derivatives sort of flow through. And airlines are certainly one place to point the finger at. But I think in general, the consumer is still in decent shape. Again, from the upper end, they're still willing to spend. They still have excess savings, from that perspective, the wealth effect. 

But at some point, a prolonged, sustained hike, maybe something close to $130 a barrel for a good 12 months, that's certainly going to have an adverse impact. 

BRIAN HESS: Yeah if the S&P 500 goes up faster than maybe the average of inflation and gasoline prices than the high-end consumer's OK. 

JACK JANASIEWICZ: Yeah. Exactly. 

BRIAN HESS: I think that you mentioned the flow through effects from oil into inflation. And that gets to another question I was hoping to ask, which is how much of the recent stubbornness in inflation do you think is attributed to oil? Let me just put it really plainly. Without $100 oil, let's say we were still at $60 a barrel or something, do you think we'd be back to target on CPI? 

JACK JANASIEWICZ: I think we'd be going in the right direction, how's that? 

BRIAN HESS: All right. 

JACK JANASIEWICZ: And-- I think that would be I mean, right now that's the biggest headache in the marketplace right now. I just was looking at the correlations between spot prices in oil and the 10-yield yield. It's at the highest in 25 years. So I think from that perspective, that bleed through is really weighing on the rate's backdrop. And it's having an out-sized impact from a historical perspective, that relationship. 

So back to your original point, yeah, if we had something back to normal levels, let's call it $60 or $70 a barrel, I think you'd see the inflation backdrop looking better. If we'd be at target, but certainly it's going in the right direction. 

BRIAN HESS: There'd be much less pressure on it. Sounds like you're saying there'd be much less pressure on the Fed to be raising rates, because they could at least point to progress. 

JACK JANASIEWICZ: Exactly. 

BRIAN HESS: Yeah, we're not there now, but we're getting there soon, hopefully. 

JACK JANASIEWICZ: Yep. 

BRIAN HESS: Makes sense. One thing I've been keeping an eye on. Usually it's a bad sign for markets when you have oil prices, interest rates, and the dollar all moving higher at the same time. Now we've got two of them pretty clearly moving in one direction. The dollar's been stable so far. So that's a good thing, I suppose, but worth keeping an eye on. 

JACK JANASIEWICZ: Yeah, and those all, I think, fold into the concept of financial conditions. And so in aggregate, those are still fairly loose, but at the margin you could make a case that you are starting to see some tightening there because of those factors you just highlighted.

BRIAN HESS: Yeah, absolutely. And despite some of the tightening of financial conditions, despite the high oil prices and all the other things we've talked about, the economy, like I said, remains really resilient. And I think that's mostly down to this AI CapEx cycle. That's been totally immune to some of these macro factors, but it's been a big driver of growth. So I think it's worth checking in on that theme this month. 

Now, we have a group chat for our investment team here, and you put some interesting charts in there that I thought we could talk about this month. One highlighted the negative correlation between AI enablers and S&P 500 ex-AI index. And it's actually a negative correlation, which means when the AI enablers are going up in price, the rest of the index is basically going down in price. Very unusual. 

And then the other thing that you showed was that there's a near 0 correlation between software stocks and semiconductor stocks, even though they're both technology stocks. Can you elaborate on these dynamics underneath the tech sector? 

JACK JANASIEWICZ: Yes. And it's certainly been a headache from a portfolio construction perspective because it's either you're in the right camp or the wrong camp if you're not balanced out. 

BRIAN HESS: It's better when everything goes up. 

JACK JANASIEWICZ: Yeah, exactly. I mean, very rarely do we actually see negative correlations like that. It's one thing to have 0 correlations, it's another to have a negative correlation. And I think this is just the product of the momentum backdrop that we're seeing in this thirst for the AI trade. 

And you're sort of getting into it, and we talked about this in our investment committee meeting there the other day, you're starting to see winners and losers, I think, a little bit more being vetted out, if you will. And so in the past, it's sort of been just one stop shop. Buy the AI-related trade and you're going to make money on it. 

I think it's becoming a little bit more fine tuned and more granular, where maybe it's just the semiconductor portion of the AI trade that's working and to a lesser extent, hardware, but some of the other tangential backdrops aren't quite as supportive. And the other day we heard the comments from Muse, the new agentic AI for personal shopping, I guess, or personal management. I don't even what you call it. 

BRIAN HESS: I haven't downloaded that one yet. So I can't chime in too much. But Meta, right, it's from Meta. 

JACK JANASIEWICZ: But that obviously-- Yeah, and look at Meta's stock. It gapped up strongly. So I think the bottom line for all of this comes back to the idea of are we seeing usable tangible benefits from AI? And more importantly, can we monetize that? 

And I think that's still the ultimate question. We talk about backlogs in a couple of our previous podcasts. We talked about revenues coming out of the cloud. But still, they're not-- The growth rates are certainly shifting in favor of that, but the absolute numbers aren't catching up.

So the absolute CapEx spend is still greater than the absolute number of revenue, even though those growth rates are starting to converge. Will that continue, will that persist, because I think that's the ultimate story here. If all of this is going to pay off, we need to see those absolute numbers start to converge.

Some signs of it happening, and I think that's given this latest leg up in tech, because of some of the things that we heard during second quarter earnings season and some of the conferences that have gone on around the tech space that I think has given a little bit of a boost back to sentiment going forward. But to continue to propel that trade forward, we need to continue to see that evidence.

And the key is going to be, I think, OpenAI and Anthropic, when you finally start to see their S1's, what are they really doing for revenues? 

BRIAN HESS: S1 will be something they have to release before—

JACK JANASIEWICZ: Before they go public. 

JACK JANASIEWICZ: Go public, issue an IPO, right. 

JACK JANASIEWICZ: And again, so much money is coming as a result from their spend. If they're not showing signs of profitability or at least moving in the right direction toward profitability, that's going to raise some, I think, red flags for the market. So I'm just highlighting that as one of the key risks going forward here is, can we start to see the big LLM companies, those frontier labs like Anthropic and OpenAI, can they show signs of actually making money and covering their CapEx. 

BRIAN HESS: So that's something clearly to focus on, would be the release of those documents, the ability of these companies to actually go public at the valuations they're hoping for and them to show some hope of profitability. It does seem like the hyperscalers are getting closer to that point, though. 

JACK JANASIEWICZ: Yeah, and that's the cloud—

BRIAN HESS: Hyperscalers are already profitable, but I mean profitable—

JACK JANASIEWICZ: But from those business lines. 

BRIAN HESS: But in terms of this investment.

JACK JANASIEWICZ: Exactly. 

BRIAN HESS: OK. All right. Well, that's something to keep an eye on. And we'll see how this plays out as we move into the fourth quarter of the year, which tends to be, as we were talking about seasonality, tends to be more bullish. And if this breakout in technology has legs. 

Now for our last topic of the day, I want to pivot to something fairly different. But you mentioned to me recently that you've been getting a lot of questions from clients about the upcoming midterm elections. So I'm curious, what are they asking about? What is the typical client wondering with respect to the midterms? 

JACK JANASIEWICZ: Yeah, I mean, it's funny because I think this started to just pop up over the last couple of weeks when I've been on the road meeting with clients. And so it hadn't really-- we hadn't really talked about it much until now. And so it's starting to come front and center. But right before I came down here, I was looking at the betting market odds to see what the potential for a Democrat sweep would look like, so both the House and Senate flipping to being democratically controlled.

It's up to 66% So again, there was some question about the Senate and then it became sort of a coin flip and 66 is, I think, pretty squarely in favor of the Democrats. Now, again, betting markets can be wrong. Still plenty of time between now and then. 

But I think that does raise some questions because if you have a Republican and White House and then a Democrat Congress, what can we expect going forward for policy? Probably not much, but I think there are some things that are worth highlighting on the back. And a couple of things that I've been talking about. 

On the health front, you probably are going to see some of the ACA tax credits extended. That's been sort of a big argument going forward for quite some time. On the consumer discretionary side, I'm sure that the Democrats will try to push through something on the affordability front. So what that means, I don't know, probably some targeted fiscal programs there, but certainly some help for that lower end of the k-shaped economy we were just talking about, to try to support them going forward. 

On the industrial side, probably a little bit more of a headwind. I think there was some optimism for next gen defensive contracts and replenishing of the arms, that sort of thing. I think defense in general is supportive, but I think incremental money that's going to develop new technologies to help on that front, that's probably going to be pushed to the back. 

Maybe some of the things that we heard about from a capital markets perspective, that gets a little bit put on hold because of deregulation probably slows down a bit. So maybe financials get a little bit of a headwind as a result of that. 

And then obviously on the energy front, you're not going to see that energy permitting going forward, there. So maybe energy gets a little bit of a ding as well. So there are some ramifications going forward, things to think about. Obviously, between now and November, things can certainly change on that front. 

BRIAN HESS: But it does seem likely that the Democrats will take at least one chamber. 

JACK JANASIEWICZ: I think that's, yeah, that's a base case assumption. 

BRIAN HESS: So it probably means just a slower policy evolution going forward and more gridlock. 

JACK JANASIEWICZ: Not a bad thing. Market usually likes that. And maybe one last thing to talk about there, typically the market rallies into the midterm elections. In about three weeks before midterms, is when you start to see the market bottom. And then the third year of a election or of a presidential cycle tends to be one of the strongest. 

So once we get towards the end of next month, the seasonals do flip bullish. And they should carry into next year. So one thing to think about on the positive side. 

BRIAN HESS: You mentioned, and that's been another question you've been getting from clients is about September seasonality. And this midterm election year just has a very different shape to it than the other three. 

JACK JANASIEWICZ: We did some work on that too, because it was always-- when you have those bad months in September, it's because you've come into the month of September not in a good position, from a technical perspective, sentiment, that sort of thing. And so a simple thing that we looked at is are we trading above the 200 day moving average as of the end of August as an indicator of the market's in good shape. 

And it's interesting because when you go into September and you are trading above the 200 day, those odds flip in favor of actually September being a good month. It's when you're coming in and you're sort of already weak, it just tends to get even weaker. And so a little bit of a nuanced version of that same September is usually a bad month thing. It's what are you doing coming in. 

And we came in this time around above the 200 day. So maybe we'll break that habit. But from that perspective, it should be supportive. We've still got, what, we're cutting this on the 22nd. 

BRIAN HESS: Eight days? Eight trading days, eight calendar days. 

JACK JANASIEWICZ: So we'll see. 

BRIAN HESS: That's interesting to think about seasonality like through the lens of existing conditions, as you start the different windows. 

JACK JANASIEWICZ: Yep. 

BRIAN HESS: All right. Well, thanks Jack. I appreciate it. It was good to sit down for another Tactical Take. 

It felt like it had been a while between recordings. I don't know it had been or if just a lot went on, but anyway, good to catch up. 

JACK JANASIEWICZ: There's always a lot going on. 

BRIAN HESS: Always a lot going on. Thanks, everyone for listening. We'll see you next month. 

JACK JANASIEWICZ: Thanks, Brian.