Global Economy Slowing as Middle East Conflict Bites, Surveys Show S&P’s eurozone Purchasing Managers Index fell to 47.5 in May from 48.8 in April

Business activity in Europe and Asia has slowed in May as energy costs have risen and new orders cooled, an indication that the global economy has been weakened by the fallout from the conflict in the Middle East. (…)

S&P said its Purchasing Managers Index for the eurozone—which measures activity in the services and manufacturing sectors—fell to 47.5 in May from 48.8 in April.

That marked the sharpest decline in activity since October 2023. (…)

As in other parts of the global economy, manufacturing continued to receive support from businesses bringing forward purchases in an effort to avoid even higher prices in the future, or difficulties in securing needed products.

By contrast, activity in the much larger services sector declined at the fastest pace since February 2021.

“The service sector is being hit especially hard by the surge in the cost of living created by the war,” said Chris Williamson, chief business economist at S&P Global Market Intelligence.

He said the PMI measures for April and May point to a 0.2% decline in eurozone gross domestic product in the second quarter, following a small increase in the first three months of the year.

In the U.K., the sharpest drop in services since January 2021 led to a drop in overall activity. The U.K. economy recorded a stronger start to the year than most of its peers, but the surveys suggests that momentum has faded fast.

Of the countries surveyed, France was hardest hit, with its national PMI pointing to the largest drop in activity since late 2020, when the global economy was in the throes of the pandemic.

Activity also fell in Germany for a second straight month, although to a more modest extent.

Australia saw a swing to contraction, while new orders declined at the fastest pace in over four-and-a-half years. Indeed, new orders cooled in all of the surveyed economies, suggesting the slowdown in activity is set to continue over coming months.

While the conflict appears to be slowing economic growth, it is also reigniting inflation, which had been falling back from the surge that followed Russia’s invasion of Ukraine in 2022.

In the eurozone, businesses reported that their costs rose at the fastest pace in three-and-a-half years, while the prices they charge in turn rose at the most rapid clip in 38 months. Based on historic patterns, S&P estimates that those increases point to consumer-price inflation of around 4% over coming months, double the European Central Bank’s target.

Japanese companies raised selling prices again in May in response to climbing expenses, the S&P data showed. Notably, the rate of charge inflation—-which captures the pace at which businesses are raising sale prices—-across both goods and services was the sharpest in nearly 19 years, though the pace still lags behind the increase in input costs.

That combination of weakening activity and rising inflation presents central banks with some difficult choices, as any steps they take to contain inflation would likely exacerbate the economic slowdown and the accompanying job losses.

The surveys pointed to declines in payrolls in France, Germany, the U.K. and Australia, although businesses in Japan and India continued to hire additional workers.

“Job losses are also starting to become worryingly widespread as business confidence in any swift turnaround in the adverse economic climate fades further,” said Williamson.

Charlie Bilello’s table shows that globalization now also includes inflation:

Former NY Fed president Bill Dudley: Ignore This Bond Market Slump at Your Own Peril

(…) the economy’s performance has caused market participants to revise up their longer-run expectations about the level of short-term rates that is consistent with a neutral monetary policy. It isn’t credible to judge monetary policy as restrictive when short rates have been above current levels for more than three years and the unemployment rate remains at a level judged by monetary policymakers to be consistent with full employment and stable inflation.

The SOFR futures market, which shows the expected short-term rate path for several years, is around 4% after 2026, compared to the Fed’s current federal funds rate of 3.50% to 3.75%. If short-term rates are expected to be higher, then bond yields need to move up as well.

(…) the term premium that bond investors demand to hold longer-term Treasuries rather than shorter maturity ones has risen above the level prevalent in recent years. That should not be surprising given that the premium was unusually low following the Great Financial Crisis. Between 2009 and 2021, the worry was that short-term rates could be pinned close to zero and that the Fed would lose the ability to make monetary policy stimulative.

In that environment, bonds were attractive and the term premium was around zero and even lower. However, prior to the GFC in environments more similar to today, the average spread between three-month Treasury bill rates and 10-year Treasury note yields was about 100 basis points. That is comparable to where the spread is today.

Despite this sanguine assessment, there are several reasons for deeper concern. First, the US remains on an unsustainable fiscal path and the situation is worsening. On the expenditure side, the Iran war is boosting defense outlays, with President Donald Trump seeking a $500 billion increase to defense spending in fiscal 2027 at the same time higher interest rates are pushing up the government’s debt service costs.

The bipartisan Congressional Budget Office projects that debt service costs will move sharply higher as chronic budget deficits drive up the federal debt burden and as low-cost debt issued between 2009 and 2022 and is refinanced at higher interest rates.

In the CBO’s 10-year projections, debt service costs rise from 3.3% of GDP in 2026 to 4.6% of GDP in 2036. Moreover, if rates are markedly higher than the CBO assumes (around 3.2% for the 3-month Treasury bill and federal funds rates and 4.3% for the 10-year Treasury note yield) then debt service costs will be much higher too.

The CBO calculates that a 1 percentage point increase in the level of rates above what it has assumed would increase debt service costs by $600 billion in 2036 and$3.8 trillion over the next 10 years. On the revenue side, recent court rulings with respect to the legality of the Trump administration’s tariffs have created a new budget hole.

Second, concerns about the ability of the Fed to maintain its independence in its conduct of monetary policy could lead to a significant further rise in bond term premia. If investors fear that the Fed won’t be able to get the inflation rate back down to 2%, then inflation expectations will become unanchored and bond risk premia will increase even further. The fact that inflation has already been above the Fed’s 2% objective for five years increases the risk of such a loss of confidence and higher bond yields.

Third, the dynamics here are self-reinforcing. Higher deficits lead to higher interest rates. The CBO estimates that every 1 percentage point increase in the nation’s debt-to-GDP ratio raises long-term rates by 2 basis points. The 20 percentage-point rise in the federal debt-to-GDP ratio that the CBO projects over the next 10 years would imply a 40 basis point rise in long term rates. And, as the debt burden climbs, investors become more worried that the solution will be one of fiscal dominance in which monetary policy is subordinated to fiscal policy.

As the renowned economist Rudi Dornbusch explained it, financial crises take much longer than expected to arrive, but when they do, they come on much faster than one might have anticipated. If this occurs, a loss of confidence and a sharp rise in long-term rates would make the fiscal situation unsustainable—the bond market vigilantes—not seen since the 1990s–would be back.

Former US Treasury secretary Robert Rubin with a different angle, in the FT: Americans beware: markets can be out of sync with reality

(…) By now, markets and the economy seem largely inured to the chaos, leading some to conclude that Trump’s policies have not resulted in the serious economic damage many predicted. I disagree.

While not yet reflected in short-term data, I believe enormous damage has been done to the economy, with effects likely to play out over time. Markets can be out of sync with reality for an extended period, and then react rapidly and harshly.

In the 18 months leading up to October 1987, the stock market soared, despite concerns about looming risks. Then, on October 19, the Dow fell by 22 per cent in a single day. More recently, Greek sovereign debt traded at very narrow spreads to others in the Eurozone for years, despite worries about Greece’s fiscal and economic conditions. Then, all of a sudden, Greek debt collapsed, triggering the European sovereign debt crisis.

Some recent policy choices have made existing problems worse: rather than addressing our unsound fiscal trajectory, we’ve enacted trillions in deficit-financed tax cuts; we have failed to reform our costly and inefficient healthcare system; and we’ve undermined support for less expensive alternative energy sources at a time when AI is driving up electricity demand and China is racing ahead with renewables. These choices will probably increase prices and diminish growth, while leaving the country less resilient. 

Other actions have introduced largely new problems — like politicising the Fed; assailing our universities; slashing federal support for scientific research; attacking undocumented workers who play a key role in construction and agriculture; placing new constraints on legal immigration; and imposing tariffs that increase prices and reduce growth. And while regulation was excessive at times, Doge’s slash-and-burn approach was hugely harmful to government functions. (…) disruption and uncertainty can wear away at an economy over time.

America’s economy and national security have largely been well served by the postwar global order. But now we’ve become a source of instability. We’ve disparaged our Nato allies, pursued ownership of Greenland, seized the leader of Venezuela and waged a consequential war with Iran without coherent objectives. We’ve punished the dissent that is a hallmark of US democracy. And we’ve undermined faith in the rule of law — one of our economy’s underlying strengths, and a great advantage vis-à-vis China.

Our economy, and our society, has done well under Republicans, under Democrats and with power divided between them. But this administration’s approach is radically different. It is driven by an authoritarian mindset, with extreme approaches that lie outside the traditional public policy debate and are not grounded in intellectually serious analysis. 

I do not mean to sound pessimistic. With the great strengths that it has, the US should remain the most attractive market for investment and economic activity. But we must avoid being lulled into complacency by a stock market that has performed well and economic conditions that are still reasonably solid. 

By the time these measures react to the damage being done, it may be far harder to get the economy back on track. This is a moment when our citizens can engage in the hard work of re-establishing government that respects our laws, bases action on fact and engages constructively with the rest of the world. We can do that by supporting fair and free elections, and candidates — whether conservative or progressive — who pass a simple test: are they serious about addressing the economic challenges before us, including those that our own recent actions have created?

Dimon Says Rates Risk Going Much Higher Even After Bond Selloff

(…) “We may have gone from a saving glut to not enough savings.” (…)

“US government debt is $30 trillion, the average rate is 3.5%. Even today they can’t possibly refinance it lower than that rate,” Dimon said. “They have another $2 trillion to do this year but the thing is we don’t know when — we don’t know when the world gets too scared about that, when inflation makes it where people don’t want to own long-term duration securities.”

He added that the impact will also be felt in the credit market.

“Rates can easily go up more, and credit spreads can go up more,” Dimon said. “At one point you’re going to have lots of people having to refinance at higher rates.”

The FT reports that Dimon also said

In response to a question about whether China had emerged as a safe haven amid the upheaval in other parts of the world, Dimon said: “They are more consistent with other countries — that’s been true a little bit recently.” (…)

“America is still a safe haven — we just surprised people recently.” (…)

Global investors have begun to rethink China as the country moves up the value chain in fields such as renewable technology and industrial hardware. Dimon praised the country’s innovation, saying investors have long been interested in “their cars and their batteries and their solar and their machine tools”. (…)

• The Dangerous Brew That’s Rattling Bond Markets A mix of debt, inflation and populism has changed the interest rate landscape since 2020

But the bigger driver over the past year is that investors want more compensation for lending over many years instead of a few months.

That reflects a judgment that debt, inflation and populism—all prominently at work in the past week—are going to be around for a while. They don’t mean a bond market crisis in the offing. But together they are likely to put upward pressure on interest rates for years to come. (…)

[Trump] administration projects the budget deficit rising 16% this fiscal year to $2.1 trillion. Trump has requested a record $1.5 trillion for the Pentagon for next year. That is a lot of debt for investors to absorb. (…)

Sanae Takaichi was elected prime minister of Japan last year with a formidable majority but hasn’t used the resulting political capital to shrink Japan’s massive debt. Indeed, in the past week she said a new budget might be in order, to extend relief to families hit by higher energy prices, which sent Japanese bond yields up sharply.

In the U.S., Trump has proposed suspending the federal gasoline tax, which would cost $3.5 billion a month according to the Committee for a Responsible Federal Budget.

The rise of populists on the left and right make any serious attempt to reduce deficits even more remote. Despite a huge parliamentary majority, British Prime Minister Keir Starmer faces stiff resistance to spending cuts from his Labour Party’s left wing. His leadership may soon be challenged by Greater Manchester Mayor Andy Burnham, a socialist who has said Britain should not be “in hock to the bond market.” That prospect fed the recent rise in British yields. (…)

Since then [2020], shocks have tended to push inflation higher: the supply-chain disruptions following Covid, Russia’s invasion of Ukraine, Trump’s tariffs, and the closure of the Strait of Hormuz.

We think of these as “one-off” events after which inflation will naturally return to 2%.

But what if they are symptoms of a world more prone to supply shocks because of war, geopolitical rivalry, protectionism, populism and extreme weather? As the shocks accumulate, the public may expect higher inflation indefinitely.

In the latter scenario, central banks will regularly need to raise rates to return inflation to 2%, the opposite of before 2020. Bonds won’t insure against falling stocks, so investors will demand higher yields.

Deficits and inflation, treated so far as separate and distinct, may feed off each other. Anxiety about the cost of living has eroded politicians’ popularity everywhere, making them even less willing to propose cuts to government benefits or higher taxes.

If the Fed must repeatedly raise rates, that adds to deficits. The Committee for a Responsible Federal Budget estimates the recent rise in rates, if sustained for a year, would add $200 billion to deficits over a decade. Leaders might pressure central banks against raising rates, which would also lead to higher inflation. (…)

Remarkably, despite debt, tariffs, oil and Trump’s attacks on Fed independence, bond investors remain sanguine about inflation. Beyond the next few years, they see it returning to around 2%.

That’s a comforting vote of confidence in Warsh. But earning that confidence may mean overseeing higher rates than either he or Trump thought likely. Which a mixture of debt, populism and inflation just might require.

Add the fact that the worldwide push to more military spending, more AI spending and more renewables spending are all considered mandatory, urgent and thus cost insensitive. Plus Trump’s “little excursion” in Iran having upended world supply chains, forcing governments and companies to hoard broadly and keep inventories higher than normal. Higher costs, higher financing requirements.

David Rosenberg:

Trump’s continued grip on the Republican Party increases the odds that Republicans can push through a summer omnibus bill with new fiscal stimulus to bolster their midterm prospects. Recent primary defeats of Trump-skeptical
Republicans underscore the pressure on the caucus to stay aligned with the White House, even as razor-thin House margins leave room for lame-duck members to rebel.

The net effect is a more polarized but less predictable fiscal backdrop with higher odds of short-term stimulus.

Markets might be underestimating how much the world has changed.

Warsh and Peace (John Authers)

When nominated in January, Warsh was a dove who intended to cut rates. A month later, war broke out in Iran, and with it changed the entire nature of his job. On Feb. 27, futures implied that the fed funds rate would be about 2.8% next summer; now, even with Warsh in place, it’s expected to top 4%:

The Federal Open Market Committee that Warsh will now chair appears from the minutes of Jerome Powell’s final meeting to be comfortable with these expectations, and more hawkish than previously thought. The Fed is coy about exact numbers of votes, but word choices paint a picture of a building consensus for tightening:

Almost all participants noted even after the conflict ended, the prices of oil and other commodities could remain elevated for longer than expected;

Almost all expected “continued upward pressure on inflation arising from supply chain disruptions, high energy prices, or the pass-through of higher input costs to other prices” if oil prices did stay high;

The vast majority noted an increased risk that inflation would take longer to return to 2% than they had previously expected;

A majority highlighted that some policy firming would likely become appropriate if inflation were to continue to run persistently above 2%;

Many would have preferred removing the language from the post-meeting statement that suggested an easing bias.

The sole change in the committee will see Warsh replace Stephen Miran, its most extreme dove. So his chances to corral a majority for cuts look negligible. He will have delivered for Trump if he can just dissuade his colleagues from hiking. Steve Englander of Standard Chartered Plc describes the Warsh FOMC as “capping rates rather than cutting,” while TS Lombard’s Steven Blitz suggests that for the new chairman, “no hike in June is a rate cut.”

Englander suggested that Warsh could “delay hikes by pointing to low unit labor cost growth, trimmed-mean inflation and a couple of other indicators.” Still, this wouldn’t justify cuts.

Ed Yardeni:

(…) the minutes of the April FOMC meeting showed that the vote to maintain an easing bias was close. There was considerable support for dropping it and adopting a tightening bias. Changing to a neutral stance wasn’t seriously discussed. (…)

The minutes state that “a majority of participants highlighted that some policy firming would likely become appropriate if inflation were to continue to run persistently above 2 percent.” Furthermore, “the vast majority of participants noted an increased risk that inflation would take longer to return to 2 percent than previously expected.”

Several participants also flagged the risk that elevated inflation could begin to entrench itself in wage- and price-setting decisions, the precondition for hiking interest rates in response to a supply shock.

The minutes project a committee acutely concerned about its credibility and willing to tighten if inflation persists above the 2% target. Participants explicitly discussed the nightmare scenario in which sustained elevated energy prices, combined with tariff effects, could lift the anchor on inflationary expectations. Fed members characterized inflation persistence as “a salient risk” that is “skewed to the upside.”

The ongoing closure of the Strait of Hormuz and the latest batch of strong economic indicators suggest that upside risks to inflation now outweigh the downside risks to employment. The April minutes show that the FOMC was turning more hawkish, even though the easing bias was maintained.

We are sticking to our call that the Fed will shift from the easing bias in April to a tightening bias at the June FOMC meeting, followed by an FFR hike in July. The Bond Vigilantes can take comfort in the fact that the FOMC has become more vigilant about the current inflation problem.

Iran Says the US’s Latest Proposal Has ‘Narrowed the Gaps’

(…) Tehran is in the process of responding to a text submitted by the US, which “has narrowed the gaps to some extent,” the semi-official Iranian Students’ News Agency reported on Thursday, without saying where it got the information. “Further narrowing requires an end to the temptation for war on Washington’s part.”

The exchange of messages is based on Iran’s 14-point text from several weeks ago, the Iranian foreign ministry said separately. That plan essentially suggests a short-term deal that would see Iran reopen the Strait of Hormuz and the US lift a blockade of Iranian ports, with the warring sides then going into deeper negotiations over Tehran’s nuclear program.

Field Marshal Asim Munir, who has positioned himself as the most powerful person in Pakistan, is visiting Tehran on Thursday, ISNA reported. Islamabad is the main mediator between the sides. (…)

US President Donald Trump told reporters on Wednesday that the US was in the “final stages” with Iranian diplomacy, sparking investor hopes a deal was close. (…)

Iranian President Masoud Pezeshkian insisted the country was not on the brink of giving in. “Forcing Iran to surrender through coercion is nothing but an illusion,” he posted on X on Wednesday. (…)

Axios, citing unnamed sources, reported that Trump and Israeli Prime Minister Benjamin Netanyahu had a tense call on Tuesday.

The report came shortly after Trump told reporters that Netanyahu would “do whatever I want him to do.

Earlier, Iran warned it would retaliate beyond the Middle East if the US or Israel renewed hostilities.

“If aggression against Iran is repeated, the regional war that had been promised will this time extend beyond the region,” the Islamic Revolutionary Guard Corps said, according to the semi-official Tasnim news agency. The IRGC, which has gained even more influence over Iranian decision-making since the war erupted, vowed “crushing blows in places you do not expect.”

AI CORNER

Two hours that changed AI

Over the course of two hours Wednesday afternoon, the AI industry produced an extraordinary stream of headlines mapping out the vast architecture of its ambitions.

One historic news cycle peeled back virtually every layer of the AI revolution — smarter systems, exploding revenues, roaring markets, staggering infrastructure demands and a federal government racing to catch up.

Together, Wednesday’s developments helped crystallize the core pillars of the emerging AI order.

1. Brains: OpenAI announced that one of its general-purpose reasoning models autonomously cracked a famous geometry problem that had stumped mathematicians for 80 years. The implications are enormous: an AI capable of original mathematical discovery could eventually unlock breakthroughs across science, engineering and medicine.

2. Demand: Anthropic’s explosive growth has the company on track for its first profitable quarter, with revenue set to more than double to $10.9 billion in Q2, the Wall Street Journal reported. The estimated $559 million operating profit arrives two years ahead of internal projections — a turning point for an industry whose spending has long outrun its earnings.

3. Power: Anthropic expanded its compute partnership with SpaceX, agreeing to spend roughly $1.25 billion per month through 2029 for access to the company’s Colossus supercomputing infrastructure. Ahead of SpaceX’s IPO next month, the deal cements Elon Musk as a major power broker in the AI economy, where access to compute infrastructure is becoming as strategically valuable as the models themselves.

4. Chips: Nvidia delivered another monster quarter, posting $81.6 billion in revenue — with its data center business alone bringing in $75.2 billion. CEO Jensen Huang said demand has gone “parabolic” and described the AI boom as the “largest infrastructure expansion in human history,” reinforcing Nvidia’s dominance over the hardware powering the economy.

5. Wall Street: SpaceX’s long-awaited IPO filing revealed a company rapidly transforming into an AI infrastructure giant, with massive compute operations and ambitions stretching far beyond rockets and satellites. The blockbuster filing arrived as OpenAI and Anthropic also race toward potential public offerings this year that could value all three companies in the trillions of dollars.

6. Government: President Trump has summoned top tech CEOs to Washington Thursday for the signing of his highly anticipated AI executive order, prompted by mounting cybersecurity fears. The order is expected to establish a voluntary framework for labs to share new models with the government 90 days before release — formalizing a new dependency between Washington and the frontier labs.

Lurking behind the AI industry’s extraordinary momentum is a deepening sense of public anxiety about the pace and scale of disruption.

• Meta began laying off roughly 8,000 workers Wednesday, even as CEO Mark Zuckerberg ramps up one of the most aggressive AI spending sprees in corporate history.
• Recent polling shows that 70% of Americans fear AI is advancing too quickly. Nearly two-thirds say it’s unlikely AI will create economic gains that benefit everyone.

Nvidia Tells Skeptical Investors AI Is Ready to Go Mainstream

(…) Though spending has continued to surge from large data center clients — a group known as hyperscalers — Nvidia predicted that a vast array of other businesses and governments would soon become a bigger source of revenue. They’re poised to snap up Nvidia’s chips and other computing products to support their own artificial intelligence ambitions.

Down the road, so-called physical AI will bring a colossal new opportunity in the form of robots and automated vehicles, Chief Executive Officer Jensen Huang said on a conference call with analysts. “We’ve got it all covered,” he said. (…)

Sales in the three months ending in July will be about $91 billion, the company said in its quarterly report. That topped the average estimate of $87 billion, though analysts’ projections ranged as high as $96 billion, according to data compiled by Bloomberg. (…)

“The build-out of AI factories — the largest infrastructure expansion in human history — is accelerating at extraordinary speed,” Huang said in a statement.

Data center spending, which is the main source of Nvidia’s revenue, hasn’t shown signs of letting up. Hyperscalers plan to shell out a combined total of roughly $725 billion on AI this year. And based on Nvidia’s latest results, revenue from those companies continues to outpace other sources. (…)

The company has said it has more orders than it can fill and is investing to add supply to meet that demand.

In the three months ended April 26, Nvidia’s sales gained 85% to $81.6 billion. Analysts had estimated $79.2 billion on average. Profit, minus certain items, climbed to $1.87 a share. That beat a projection of $1.77.

Adjusted gross margin, the percentage of revenue remaining after deducting costs of production, was 75%. [Net income was $58.3 billion for the quarter, more than three times the year-earlier result and 36.5% higher than the $42.9 billion analysts had predicted.]

Nvidia boosted its quarterly dividend to 25 cents a share from a penny. And the chipmaker announced $80 billion in stock repurchases. [Chief Financial Officer Collette Kress said in a conference call that the company intends to return 50% of its free cash flow this year to shareholders.]

Nvidia’s all-important data center unit generated revenue of $75.2 billion, compared with an estimate of $73.5 billion. Networking, part of the data center division, delivered $14.8 billion in sales, versus an estimate of $12.7 billion. [That was triple last year’s] (…)

The company is on course to record total revenue of more than $370 billion this year, according to estimates. By that measure, it will be roughly 22 times the size it was in fiscal 2021. Nvidia easily chalks up more sales in a quarter than its next three largest rivals combined. (…)

The company said Wednesday that it’s still not getting any data center revenue from China. [Huang has said the Chinese market for AI chips could be as large as $50 billion a year. On Wednesday, Nvidia said it wasn’t assuming any revenue from sales of data-center chips in China for the current quarter.]

Meanwhile, Nvidia continues to branch out into new areas. It’s beginning to sell general-purpose processors and is offering chips tailored to the inference stage of artificial intelligence. That’s the point where models are already trained and beginning to handle real-world inputs.

The company said it expects to get $20 billion in CPU revenue this year, which would make it the world’s largest supplier.

John Authers: “Nvidia’s revenue growth shows that the momentum of the AI data-center buildout is if anything accelerating:

 

• Mind-Blowing Growth Is About to Propel Anthropic Into Its First Profitable Quarter 

Anthropic’s revenue is set to more than double to $10.9 billion in the second quarter, an explosive rate of growth that will help it turn an operating profit for the first time.

The company disclosed the figures to investors as part of an ongoing funding round that is likely to push its valuation above OpenAI’s. The projections, which were reviewed by The Wall Street Journal, provide a window into the meteoric rise of a startup that was once a laggard in the artificial-intelligence race, and defy the conventional wisdom that AI companies’ huge spending needs hamper near-term profitability.

Anthropic generated $4.8 billion in sales in the first quarter. Its quarterly revenue is now growing faster than Zoom did during the pandemic, and Google and Facebook in the run-up to their initial public offerings. It is set to turn an operating profit of $559 million in the June quarter.

Anthropic shared financial figures with investors last summer that suggested the company didn’t expect to turn a full-year profit until at least 2028. The company might not remain profitable for the full year as it plans spending increases due to its vast computing needs. Its operating profit includes the cost to train new models and excludes stock-based compensation. (…)

Demand for Anthropic’s products has strained its computing resources and forced it to limit access for certain users. The company signed a string of new data-center deals in recent weeks to help it expand capacity, including with Elon Musk’s SpaceX.

In the first quarter, Anthropic spent 71 cents on computing power for every dollar it made. In the current quarter, it expects to spend 56 cents per dollar, a sign that the business is becoming more efficient as it grows. (…)

Compute demand is much stronger than supply. From Google this morning:

Hi Denis,

We wanted to let you know about changes to the usage limits included with your Google AI Pro subscription.

What’s changing starting today, May 20, 2026:

Usage limits in the Gemini app: For the Gemini app, we’re introducing compute-based usage limits that factor in the complexity of your prompt, the features you use and the length of your chat. Your limit refreshes every five hours until you reach your weekly limit. As an AI Pro subscriber, you’ll enjoy a four times higher usage limit than non-subscribers.

AI credits: The product-based usage limit model is also rolling out to other products, starting with Flow and Antigravity. You can extend your limits by purchasing AI credits. While 1,000 AI credits will no longer be included as a benefit in your base plan each month, the new usage limit model we are introducing should allow you to maintain the same experience you are used to.

Manus Weighs Raising $1 Billion to Unwind Meta Takeover

The co-founders of Manus are exploring options to fulfill Beijing’s demand to unwind a controversial takeover by Meta Platforms Inc., including raising about $1 billion from external investors to buy back the Chinese-founded AI operation.

Manus’s three founders — Xiao Hong, Ji Yichao and Zhang Tao — are in discussions about a round of funding at a valuation that would at least match the $2 billion Meta paid to acquire the agentic AI outfit, according to people familiar with the matter. The founders may chip in with their own money to finance the rest of the transaction, the people said. If they go ahead, the next step would entail setting Manus up as a Chinese joint venture with those backers, ahead of a Hong Kong initial public offering, one of the people said, requesting not to be named discussing private deliberations. (…)

It’s unclear how new owners would carve out Manus’s agentic AI technology, much of which has been integrated into Meta’s systems. (…)

With last month’s demand, Beijing’s regulators conveyed their determination to prevent the transfer of sensitive technology to geopolitical foes at all costs. It followed a decision to bar major tech firms including ByteDance Ltd. and Moonshot AI from taking American capital without approval, and a clampdown on offshore Chinese companies seeking to list in Hong Kong. (…)

Still, it’s unclear how Meta would unwind the deal on a practical level. Manus employees have joined Meta, capital has been transferred and the startup’s executives are now part of the US firm’s rapidly expanding AI team.

Manus staffers have already moved into Meta offices in Singapore, while investors including Tencent Holdings Ltd., ZhenFund and HSG have received their proceeds, people familiar with the matter said previously.

Raúl Castro Charged With Murder in U.S. Court

• With Castro Indictment, Trump Bets His Venezuela Playbook Will Work in Cuba

(…) “The indictment and removal of Maduro sent a clear message to his socialist allies in Havana: this is our Hemisphere and those that destabilize it and threaten the United States will face consequences,” Trump said in a message released for Cuban Independence Day on Wednesday. (…)

The island is inching closer to a humanitarian crisis (…).

But no worries:

“No, there won’t be escalation,” Trump told reporters. “I don’t think there needs to be. Look, the place is falling apart. It’s a mess and they’ve sort of lost control. They’ve really lost control of Cuba.” (…)

A de facto US blockade has cut off fuel shipments, and the country’s government has reported running out of diesel and fuel oil for its power plants, worsening blackouts that have shut down critical services on the island.

“We’ll see,” Trump said when asked how long the embargo would remain in place. “We’ll be announcing it pretty soon.”

Today:

• FOMC minutes.
• A key Treasury auction.
• Earnings: Nvidia, Target, Lowe’s, and TJX.

AI’s Macroeconomic Challenges and Promises

From the NY Fed:

In the third quarter of 2025, America’s largest tech firms for the first time spent more on capital investment than they earned from operations. The implication is that AI, a technology with the potential to make the economy more productive, is, for now, absorbing resources faster than it is generating returns. This post discusses how the tension between AI’s long-run promise and its short-run costs affects the outlooks for inflation, real activity, and financial stability. (…)

A widely held view is that AI, by raising productivity, will be a powerful disinflationary force. This view may ultimately prove correct, but it skips a crucial step. What matters for inflation is not whether AI raises productivity, but whether it raises productivity faster than it increases the costs of adopting it.

During the transition, firms divert substantial resources toward reorganization, data infrastructure, and integration, which can temporarily raise production costs even as the technological frontier expands. This is the so-called “productivity J-curve,” depicted in the figure below. (…)

Measured Productivity Can Fall During the Adoption Phase

Recent data suggest that AI-driven demand has been pushing prices up over the past two years, and those costs are now passing through to prices of consumer electronics. For example, the prices for memory chips are up substantially. A recent report indicates that energy consumption and prices are also being affected.

AI may shift the economy’s fundamentals: the level of potential output and the natural rate of interest. The critical question is whether AI generates a one-time level shift in productive capacity or a sustained acceleration in growth (see figure below). A level shift temporarily raises the natural interest rate during the transition before growth reverts to baseline, while a growth acceleration raises it permanently.

Faster AI Adoption Can Signal Either That the Economy Is Overheating or That It’s Catching Up to Its AI-Lifted Potential

To date, estimates of the productivity impact span both scenarios, from modest gains of a few percentage points of GDP over a decade to considerably larger effects if AI augments the innovation process itself. The range is wide and the uncertainty is compounded by countervailing forces, including a possible increase in market concentration and shifts in household saving and spending.

Concentration matters because AI adoption tends to be skewed toward large firms: if rents accrue to a handful of incumbents, the investment boom that lifts the neutral rate may prove narrower than aggregate figures suggest, and winner-take-all dynamics may also slow the diversity of research that sustains long-run growth.

On the household side, the fall in consumption among workers whose tasks AI displaces may be only partially offset by the gains of those it complements. If the latter tend to save a higher share of their earnings, aggregate consumption may be weaker than productivity figures alone would suggest.

Until recently, the major AI companies funded capital investment almost entirely from retained earnings, insulating the AI buildout from credit-market conditions.

That changed in late 2025: capital expenditures began to exceed operating cash flows, and the firms raised over $100 billion of new debt. Beneath those headline bond issues lies a more intricate layer—off-balance-sheet project finance vehicles funding data center construction, securitizations backed by lease cash flows, and hundreds of billions in forward lease commitments that will not appear on balance sheets for years.

Much of this debt is predicated on AI productivity returns that have not yet materialized. If expectations shift, the correction could travel quickly and widely: the same institutions—insurers, asset managers, pension funds—hold overlapping exposures across corporate bonds, securitizations, and private placements, so a broad repricing would hit them from multiple directions at once. (…)

The IT revolution of the 1900s offers a cautionary precedent. In the 1990s, Fed Chairman Alan Greenspan resisted calls to tighten prematurely, betting that IT was expanding the economy’s productive capacity. He was right. But the dot-com crash that followed showed that even when the supply-side narrative is broadly correct, expectations can generate asset-price dynamics that create independent financial stability risks. Getting the trend right did not protect against the bubble.

Today’s AI cycle features some of the same tensions as that episode—uncertain productivity effects, difficulty distinguishing supply from demand, and expectations-driven asset dynamics. But it is unfolding within a layered and leveraged financial system. As a result, the path toward an AI-driven high-productivity economy might prove to be a bumpy one.

Canada: Inflation climbs again in April, but the Bank of Canada can afford to wait

Inflation edged higher again in April, as the annual increase in prices climbed from 2.4% in March to 2.8%. However, the increase was well below economists’ consensus forecast of 3.1%.

As in March, the month-over-month increase in consumer prices was largely driven by higher energy prices amid the conflict in the Middle East. Part of the monthly increase in gasoline prices was offset by the temporary suspension of the federal fuel excise tax introduced mid-April, but energy prices still surged 19% annually, as the April 2025 removal of the carbon tax was pushed out of the year-over-year calculations.

Excluding energy, CPI fell from 2.3% in March to 1.8% in April. Meanwhile, food inflation, which is another closely watched category amid ongoing global supply chain disruptions, rose by just 0.05% month over month, a sharp slowdown from the 0.40% increase recorded in March. That said, food prices could still feel the delayed effects of the ongoing Middle East crisis, meaning it would be premature to conclude that inflationary pressures in this category have fully subsided.

Excluding food and energy, prices were also surprisingly low, as they remained unchanged monthly, resulting in only a 0.3% gain on a three-month annualized basis.

As for the measures favored by the Central Bank, they rose at a slightly faster pace—though not to an alarming extent—to 0.18% for the CPI-Median and 0.14% for the CPI-Trim. On an annualized three-month basis, they are growing at rates that are comfortable for the Central Bank, at 2.2% and 1.5%, respectively.

Since inflation in Canada was already well under control before the recent oil shock, we have argued that the Bank of Canada should look through the rise in energy prices and leave interest rates unchanged. This morning’s report reinforces that view.

Core inflation remains contained, pointing to an economy still operating with excess supply. It also reflects the continued easing in shelter costs. Indeed, a declining population combined with higher interest rates has triggered a correction in housing prices, particularly in the country’s least affordable markets. With vacancy rates increasing amid recent demographic trends, rent prices have been the biggest driver of this slowdown.

In this context, and given that the labour market registered its worst start of the year since 2009 (excluding the pandemic), we believe that the risk of second-round effects (wage-push inflation) from the surge in energy prices is limited.

True, the conflict is still not resolved, and energy prices are on track to rise again in May, meaning that annual inflation has likely not peaked yet. But interest rates already appear far from accommodative in an environment characterized by geopolitical uncertainty and ongoing trade tensions with Washington. Overall, current conditions argue for a patient approach from the Bank of Canada.

• April Headline CPI YoY: Canada +2.8%, USA +3.8%
• April Core CPI: Canada +1.5%, USA +2.7%

Same Shock, Different Roads? A K‑Shaped Pattern at the Pump

(…) with the sharp increases in gasoline prices in March, a K-shaped pattern in gasoline consumption emerged—showing faster consumption growth for high-income households relative to low-income households. These gasoline consumption patterns qualitatively match those following the increase in energy prices at the beginning of the Russia-Ukraine war in spring 2022, even though the gap in consumption trends during the current episode is quantitatively larger. (…)

The left panel of the chart below shows nominal gasoline spending rose by over 15 percent in Numerator in March 2026, going from being 10 percent below the 2023 level to being 5.5 percent above. This increase was driven by the rising price of gasoline as real gasoline consumption fell 3 percent (right panel). MARTS recorded a similar increase in gasoline station spending for March 2026 (14.5 percent). (…)

Low-income households increased their nominal gas spending by the least (12 percent). However, this was accomplished because they cut their real gas consumption the most (7 percent). On the other hand, high-income households increased their nominal gas spending by the most (19 percent) in a large part because they reduced their real gas consumption the least (1 percent). Middle-income households had intermediate increases in nominal spending and decreases in real consumption at gas stations.

Thus, the K-shaped consumption pattern in both nominal and real gasoline spending was strongly evident in March 2026. (…)

With the current energy price shock, a K-shaped pattern in gasoline consumption has opened up much more than before. Higher-income households have reduced real gas consumption only modestly and increased gasoline spending considerably compared with 2023. In contrast, lower-income households increased spending by much less and decreased real consumption by much more, potentially by carpooling or substituting to public transit where available.

• Surging fuel costs risk creating new split in the eurozone

(…) The oil price shock has quickly filtered through to households. Filling up has become noticeably more expensive across the eurozone, albeit to very different degrees. Compared with the week before the joint US‑Israeli strike on Iran, the price of a 50-litre tank of unleaded petrol has risen by an average of between €5.00 in Spain and €13.50 in Germany. For diesel, the average increase has been even steeper, ranging from €15.65 in Italy to €23.00 in the Netherlands.

The biggest differences across eurozone countries were seen in late March and early April, coinciding with the spike in oil prices. Some of these gaps have since narrowed, partly due to temporary fiscal measures in several eurozone countries.

If fuel prices were to remain at current levels for the rest of the year, annual fuel expenses would rise by roughly €70 in Italy and up to €280 for petrol in the Netherlands compared to last year. For diesel, the additional burden would range from €190 to €430. And for those still remembering the 2022 energy price shock: annual fuel expenses (in nominal terms) in the eurozone would be between 2% (Austria) and 15% (the Netherlands) higher than in 2022.

While this increase in fuel prices alone could undermine private consumption, it will do so more unevenly than many might think.

Across the eurozone, the share of disposable income spent on fuel differs markedly. Last year, households in Italy spent around 4.0% of their disposable income on fuel, compared with 6.2% in Portugal. Interestingly, this gap does not reflect cheaper fuel in Italy. On the contrary, with higher taxes, fuel prices there are at the higher end of the scale in the eurozone. The gap instead points to differences in driving habits, with Italians driving relatively few kilometres per year, and lower income levels in Portugal limiting the ability to absorb higher costs.

The increase in fuel prices so far, excluding any additional fiscal measures, is likely to widen the difference between eurozone countries in the share of disposable income spent on fuel. In the Netherlands, the sharpest absolute rise in fuel costs is pushing households to spend a much larger share of their disposable income on fuel than a year ago. Germany, France, and Austria, where people tend to drive more, are likely to face greater additional financial burdens as well, while Italy and Spain should see a more moderate increase. In Spain, the temporary reduction in the VAT rate on fuel from 21% to 10% dampens the price effect. In Italy, the below-average mileage is providing some relief.

Share of annual disposable income per capita spent on fuel

(…) higher prices at the pump are more likely to hit consumption elsewhere than behaviour. As a result, higher fuel costs are likely to increasingly crowd out discretionary spending. (…)

According to the latest European Commission survey, willingness to spend has dropped sharply in Germany and Austria – countries where disposable income is set to be among the hardest hit by rising fuel costs. Here, willingness to spend is also well below the long-term average.

Italy and Spain have also seen a decline, but spending intentions remain above their long-term averages. In France and Portugal, consumer appetite has so far held up relatively well – possibly because households there are already used to allocating a larger share of income to fuel.

Higher fuel prices are not only an energy story in the eurozone. They are quickly turning into a consumption story, and an increasingly asymmetric one. As households across the eurozone are forced to spend more at the pump, cutting down on other discretionary spending will diverge sharply across countries.

China, U.S. Reach Limited Trade Agreements on Boeing Jets, Beef Imports China’s commerce ministry said it hopes the U.S. will further eliminate unilateral tariffs in future trade talks

China agreed to purchase 200 Boeing jets and resume imports of some U.S. beef products, marking one of the clearest signs yet of easing trade tensions following last week’s summit between President Trump and Chinese leader Xi Jinping.

China’s Commerce Ministry said trade teams from the two countries held in-depth discussions on tariffs last week and made arrangements regarding bilateral tariffs measures, according to an official statement released Wednesday.

The ministry said it hopes the U.S. will honor its commitments and ensure tariff levels on Chinese goods do not exceed those agreed at the October meeting in Kuala Lumpur. It also said it hopes the U.S. will further eliminate unilateral tariffs on China in future trade talks.

Both countries agreed in principle to discuss a framework for reciprocal tariff reductions on products of equivalent value under a trade council mechanism, with each side covering goods worth at least US$30 billion.

According to the ministry, products agreed upon by both sides could eventually be subject to most-favored-nation tariff rates or lower.

If the two countries cut tariffs on roughly $30 billion worth of products, it would cover about 10% of U.S. imports from China, said Zhiwei Zhang, economist at Pinpoint Asset Management. That wouldn’t be significant enough to change the market’s China growth forecast, but it’s is a positive step in the right direction, Zhang said.

“As long as the two countries are talking to stabilize the bilateral relations, it is good news for global investors.” Zhang said. (…)

On rare earths, the ministry said trade teams from both countries had extensive discussions on export-control issues and would jointly study and address each other’s legitimate concerns. It reiterated that the Chinese government imposes export controls on key minerals such as rare earths in accordance with laws and regulations, and reviews compliant, civilian-use export permit applications.

Bloomberg explains:

The ministry’s comments are a reason for cautious optimism that the one-year cessation in trade hostilities clinched by Chinese leader Xi Jinping and President Donald Trump will remain in place.

The ministry’s statement signals Beijing would accept US tariffs provided they do not exceed the level agreed in Malaysia that brought the effective rate to about 30%. That was later reduced to an estimated 21% after some tariffs were struck down by the Supreme Court.

The Trump administration has sought new Section 301 investigations to return levies to the level before the court ruling. Treasury Secretary Scott Bessent has said those tariffs may be restored by July.

The ministry also said the US should further remove unilateral tariffs upon follow-up talks to “create favorable conditions for expanding economic and trade cooperation.”

• Xi and Putin Hail Partnership While Signing Pacts to Deepen Ties

Xi welcomed Putin on Tiananmen Square at the start of their summit, giving him the same treatment received days earlier by Trump. A 21-gun salute rang out as a military band played their two national anthems, while dozens of children holding Russian and Chinese flags greeted them and shouted, “Welcome, welcome.” (…)

Calling Xi a “dear friend,” Putin said Russia remains a reliable supplier of energy to China. “In the current tense situation on the international stage, our close cooperation is especially needed,” he said.

Chinese President Xi Jinping and his Russian counterpart Vladimir Putin praised the strength of their relationship during talks in Beijing as both countries seek to reinforce bilateral ties in the shadow of wars in Ukraine and Iran.

The two leaders signed a pact on deepening strategic cooperation on Wednesday before looking on as officials from both nations inked a series of other documents on topics ranging from trade and technology to railway construction. Putin said approximately 40 agreements had been reached during the visit, even as they didn’t mention a key gas pipeline project. (…)

Topics on the agenda at the talks between Russia and China included the planned Power of Siberia 2 pipeline, the Kremlin said earlier, though neither leader mentioned the project in remarks while signing agreements. (…)

The Chinese president said earlier that both sides are working on deepening political trust and strategic coordination. (…)

“A comprehensive ceasefire is imperative, restarting war is even more unacceptable, and adhering to negotiations is particularly important,” Xi said in Beijing.

Yesterday:

• Trump Threatens Iran With ‘Big Hit’ If There’s No Deal Soon

(…) “I hope we don’t have to do the war, but we may have to give them another big hit,” Trump told reporters on Tuesday. When asked how long he would wait, he said: “Well, I mean, I’m saying two or three days, maybe Friday, Saturday, Sunday. Something maybe early next week — a limited period of time.” (…)

The FT adds:

Xi told Putin that the crisis in the Gulf was at a “critical juncture” and reiterated calls to end the fighting and stabilise energy supplies and trade, according to comments published by Chinese state news agency Xinhua.

“Unilateralism and hegemonism are deeply harmful, and the world faces the danger of regressing back to the law of the jungle,” Xi said in a veiled criticism of the US.

More practically, the FT’s Martin Wolf reminds us:

First came the war. Then came the blockade. Now come the shortages. The tankers full of essential commodities — oil, liquid natural gas, urea, refined oil products, hydrogen, helium and so forth — have not sailed through the Strait of Hormuz since the end of February. Those that left before the closure have mostly arrived. From now on, the shipments that did not leave will increasingly be missed.

As inventories are also drawn down, we will move into an era of physical shortages.

Up to now, shortages have been mostly imaginary. Now they will become real. They must be managed, ultimately by suppressing demand. The latter in turn will require some combination of rationing and recession. A blend of higher prices with tighter monetary policy could deliver both. The longer the strait remains closed and the bigger the physical damage, the longer shortages will remain and the worse their impact.

(…) the main shortages now are in jet fuel and diesel. Given these product-specific realities, the US is not self-sufficient in oil. (…)

Finally, the shortages are far from limited to energy. Also affected are supplies of helium, naphtha, methanol, phosphates, urea, ammonia and sulphur. The reduction in supply of helium damages production of microchips. The reduction in supply of commodities essential to making artificial fertilisers will reduce global food production. There is also a negative impact on world shipping, since the longer routes are more expensive. (…)

The US called its war “Operation Epic Fury”. But “Operation Epic Folly” would have been a more realistic name.

Martin should have expanded on how shortages of sulphur would be critically harmful:

The primary industrial use of sulfur is the production of sulfuric acid, the world’s most widely used industrial chemical.

• It is primarily used to dissolve phosphate rock to produce soluble phosphate fertilizers. Sulfur itself is also a vital plant nutrient required for crop protein synthesis. Fertilizer plants face immediate raw material deficits. This causes global price spikes for key agricultural inputs like urea and phosphate. Without accessible sulfur-based fertilizers, farmers worldwide are forced to scale back usage.
• Sulfuric acid is the primary agent used in ore leaching to extract and purify critical minerals like copper, nickel, cobalt, and lithium. Production of high-performance Lithium-ion batteries depends on cobalt, lithium, and High-Pressure Acid Leaching (HPAL) of nickel. A sulfur crunch could stall electric vehicle supply chains. Roughly 20% of the world’s copper supply relies on sulfur-dependent extraction. Shortages instantly inflate processing costs, threatening the rollout of electrical grids and renewable energy infrastructure.
• It serves as a vital component in semiconductor chip manufacturing (used for cleaning and cooling chips), the production of lead-acid batteries, rubber vulcanization (tires), and the synthesis of pharmaceuticals. A supply deficit slows down microprocessor fabrication lines. This ripple effect limits the manufacturing capacity for everyday essentials, ranging from smartphones and medical devices to automotive computer systems.

The issue is not price, it’s the physical availability.

• EU explores fertiliser stockpiling as food crisis looms

The European Commission said it would assess “preparedness options for key fertilisers”, including requiring member states to have seasonal or minimum stocks, and potentially putting in place joint procurement of fertilisers and their components.

The measure is one of several moves by the Commission to tackle the high prices of crop nutrients and secure supplies, in a package unveiled on Tuesday.

Presenting the plan, commissioner for agriculture Christophe Hansen said: “Food security starts with fertiliser security. Europe must produce more and depend less on others for the nutrients that sustain our agriculture.”

Before the war, as much as a third of globally traded fertilisers transited through the Strait of Hormuz, leaving food supply chains exposed to disruption from the US-Israeli war against Iran.

Nitrogen-based fertiliser prices last month were approximately 70 per cent above their 2024 average. Gas accounts for as much as 80 per cent of their costs. (…)

The proposal comes amid a broader shift towards strategic stockpiling of food and agricultural inputs, as governments increasingly treat supply chains as a national security issue after successive shocks from the pandemic, the Ukraine war and Middle East tensions exposed vulnerabilities in global trade. (…)

Hoarding is going broad and global.

Samsung Faces Chip Plant Strike That Threatens Global Supply

Talks between Samsung Electronics Co. and its largest labor union broke down, raising the prospect of a strike that may disrupt global chip supply and hamper an important engine of Korean economic growth.

A general work stoppage will go ahead on Thursday after Samsung’s management rejected a proposal from government mediators that had been accepted by the union, labor leader Choi Seung-ho told reporters. Hours later, South Korean labor minister Kim Young-hoon called for direct negotiations between the two sides, though it’s unclear whether even that intervention could resolve their differences. (…)

The collapse in negotiations puts the global technology supply chain at risk because Samsung is the world’s biggest supplier of the chips that go into devices from data center servers to smartphones and electric vehicles. The global AI infrastructure rollout has enriched South Korean companies on a scale not seen before, putting Samsung on track to become one of the world’s most profitable firms this year. Its semiconductor arm posted a 48-fold jump in profit for the March quarter.

More Koreans are demanding a greater share of those earnings after SK Hynix Inc. agreed last year to allocate 10% of annual operating profit to a performance bonus pool. Samsung’s lingering labor dispute, which puts the company at risk of production delays and complications accelerating development of its next-generation semiconductors, is being closely watched by other firms. On Wednesday, a union at Korean internet company Kakao Corp. said some of its members agreed to strike following failed wage negotiations, Yonhap reported. (…)

The union wants Samsung to scrap an existing bonus cap, allocate 15% of its operating profit to worker bonuses and formalize those terms in employment contracts.

Samsung had proposed allocating 10% of operating profit to bonuses, along with a one-time special compensation package that exceeds industry standards. Samsung executives argued that the union’s demands would be difficult to sustain over the long term. (…)

The government has previously hinted that it could resort to rarely used emergency powers to prevent a strike if the parties fail to reach an agreement. South Korea has invoked the emergency arbitration mechanism only four times since 1969. The last time was in 2005, when Korean Air pilots went on strike.

The Bank of Korea forecast that the strike could lead to as big as a 0.5 percentage point cut in Korea’s GDP growth this year, local media reported. (…)