Note: Sorry for delays today. My host was in maintenance mode.

Fed’s Beige Book Shows Economic Activity Up Modestly

US economic activity increased modestly in the past two months with demand from data centers, in particular, driving growth, the Federal Reserve said.

The outlook for the economy was “positive,” according to the US central bank’s Beige Book survey of regional business contacts released Wednesday, though sentiment was mixed across sectors amid uncertainty about energy prices and geopolitics.

While spending on high-end purchases was solid, the report also noted increased price sensitivity. Manufacturing activity grew across most of the Fed’s districts on the back of demand for defense and data-center orders. Employment rose slightly across the country. (…)

Prices, meanwhile, accelerated moderately in most districts.

“Consumer-facing contacts in a few districts noted that heightened price sensitivity among customers was putting a limit on their ability to pass through input price increases,” the report said. (…)

But the Atlanta Fed’s GDP Now has Q3 GDP up 4.8%!

New York Fed President John Williams yesterday echoed Scott Bessent: rising Treasury yields are driven by “a strong US economy and a strong economic outlook fueled by big investments in AI and data centers and technology in general.”

AI-related growth is offsetting whatever weaknesses there are. Note that this chart has a single scale.

One of the problem with AI growth is that its urgency makes it totally insensitive to prices and financing costs. Nvidia is also acting as the central banker of the AI economy.

Williams rightly said there are “no clear signs right now” whether current policy is sufficient to return inflation to target.

There are also no clear signs that monetary policy actually matters nowadays. Read on.

The Bond Market’s Signal Is About to Get Louder More aggressive rate hikes will be needed to tame inflation and bond yields that have yet to peak.

The Treasuries market is flashing a warning signal: the US economy has become increasingly insensitive to interest rate increases by the Federal Reserve. To combat inflation and tame yields on long-dated debt, more aggressive hikes will be needed. That means bonds will keep losing value as yields have yet to peak.

• The transmission of monetary policy has become slower and more uneven, with pockets of acute vulnerability in consumer credit and corporate debt too.
• In this environment, modest interest rate increases fall short, allowing inflation to be sticky enough to push measures of long-term price expectations higher.
• Yields on long-dated Treasuries, that peaked around 5% in the last hiking cycle, could push even higher this time.
• While equities are resilient as earnings and spending grow, the risk of more Fed rate hikes acts as an overhang on the market.

(…) The single largest structural change is the dominance of long-term fixed-rate mortgages. In the 1980s, adjustable-rate mortgages were far more prevalent. That meant Fed hikes transmitted almost immediately to household budgets. Today, the vast majority of US homeowners hold 30-year fixed-rate mortgages. And since many of those were refinanced at historically low rates during 2020 and 2021, debt-servicing costs remained around 10% of income despite the 2022–2023 hiking cycle.

On the corporate side, it’s similar. In the 1980s, corporate America carried more floating-rate bank debt and had less access to deep, long-duration bond markets. Investment-grade and high-yield bond markets since then have allowed companies to lock in long-term fixed-rate financing, reducing their immediate exposure to rate moves. (…)

The pain of higher rates was meted out, then, to lower-income borrowers via credit cards and auto loans. That produced a K-shaped outcome, or a so-called ‘vibecession,’ which in parts of the economy was very real. The double whammy of inflation and higher interest rates disproportionately impact lower-income households and small businesses. (…)

Thanks to AI spending, recession is even less of a concern this time around. (…)

• One important point is that this is a global selloff, which makes it hard for the US to buck the trend.
• No one knows where the tail risks are yet. They could be in Japan, where intervention is ongoing.
• Meanwhile, the bond market’s gains after US Treasury buyback plans were announced have evaporated.
• The potential for the Iran War to last into 2027 heightens the risks.

Add urgent military spending, urgent green spending, urgent supply chain spending, all price insensitive.

But more and more Americans are price sensitive:

• The owner of the Circle K brand reported fuel revenues of $16.7 billion in its fiscal first quarter, up 33% from the same period last year. Same-store fuel volumes fell by 1.6% in the US and 4.3% in Europe and other regions, and increased by 1.1% in Canada. Same-store merchandise revenues rose by 1.7% or less across all markets in the period ended July 19, largely missing estimates from analysts surveyed by Bloomberg, and well below inflation.
• The 60+ day delinquency rate on US subprime auto loans is up to ~5.2%, the highest on record. This figure has more than doubled over the last 4 years. Serious delinquency rates on subprime auto loans are now ~1.7 percentage points above their 2008 Financial Crisis peak. At the same time, 60+ day delinquencies on prime auto loans are up to ~0.4%, near their highest since 2011. Meanwhile, total US auto debt surged +$28 billion in Q2 2026, to a record $1.71 trillion. Americans are falling behind on their car payments at a historic rate. (@KobeissiLetter)

One offset:

America’s Population of 401(k) Millionaires Keeps Growing, Buoyed by Markets

The number of millionaire 401(k) accounts at Fidelity Investments rose 19% to a record 769,000 between the first and second quarter, according to a report released Thursday. It was the largest quarterly increase since the fourth quarter of 2023, the company said.

Aiding savers was a blockbuster quarter for equities. The S&P 500 Index gained about 15% in the three months ended June 30, its strongest performance since 2020. The average 401(k), 403(b) and IRA account balances on Fidelity’s platform rose to all-time highs, while savings rates for workplace retirement plans also held at record levels, the company said. (…)

Retirement savers are hitting the landmark even while many report feeling underprepared for their later years. The share of workers who say they feel confident about having enough money to live comfortably throughout retirement fell to the lowest level since 2017, according to a joint Retirement Confidence Survey from the Employee Benefit Research Institute and Greenwald Research released earlier this year.

Debt, inflation and rising housing and healthcare costs are hampering savings plans, according to the research. Others are worried about the future of Social Security. New projections from June estimate that the Social Security Trust Fund may be depleted by 2032.

Estimates vary widely on how much people need to save for retirement. The size of that nest egg depends on where they live, their expenses, financial goals and desired standard of living. Americans say they need $1.46 million on average to retire comfortably, according to Northwestern Mutual’s 2026 Planning & Progress Study. (…)

“It’s maybe not as big a deal to be a millionaire as it might’ve been when you watch Gilligan’s Island in the ‘60s,” he said. “The millionaire was a rich person. Now, it just doesn’t go as far as it used to.” (…)

At some point, interest rates will start to bite.

• On spending
• On margin debt

Margin debt, as it has during other speculative periods, is growing considerably faster than either credit card debt or mortgage debt. Maybe the Federal Reserve (Fed) should consider hiking margin requirements instead of the fed funds rate? (RBA)

• On asset allocation. 10Yr yields at 5%+ with inflation below 3% and a resolutely (?) hawkish Fed could become more widely appealing.

Especially if productivity offsets other inflationary pressures:

Dell Results Suggest AI Productivity Boom Is Here

Dell Technologies’ stock price is soaring. The company delivered a major beat across the board for its fiscal 2027 second quarter (ended July 31), driven by massive, accelerating demand for AI infrastructure and strong legacy hardware performance.

Revenues and earnings rose 58% y/y and 203%, respectively. AI server revenue rose 100%, while traditional servers and networking revenues rose 122%.

The results confirm that the AI infrastructure buildout remains in full swing. Strong demand for AI compute capacity points to accelerating AI adoption across the economy, which we think will drive a productivity boom. (…)

Productivity growth has rebounded since it last bottomed in Q2-2017 at 0.85%, based on the annualized average of its seven-year growth rates. It rose to 2.4% during Q2-2026, slightly exceeding its historical average of 2.3%. We predict that this growth rate will rise to 3.0%-4.0% by the end of the decade.

From the NY Fed:

AI Adoption Has Become Much More Widespread in the Workplace

Our August business surveys asked firms in the New York and Northern New Jersey region whether they used AI as part of their business processes in the past six months, questions we have asked each year since 2024.

AI adoption in the workplace has continued to increase sharply and has now become widespread. As shown in the chart below, 61 percent of service firms reported using AI this year, up from 40 percent last year and 25 percent in 2024.

Businesses in knowledge-intensive sectors, such as information, business services, and finance, had the highest usage rates. Among manufacturers, 51 percent reported using AI as part of their business processes, roughly double the 26 percent from last year and triple the 16 percent in 2024. These shares are toward the high end of the range of existing studies of AI use in the workplace.

While AI adoption has become widespread, most firms have made only limited investments in the technology. Three-quarters of service firms and more than 90 percent of manufacturers characterize their AI investments as minimal to modest, ranging from use of free AI tools to allocating a small share of overall spending to AI tools or services.

Meanwhile, just 15 percent of service firms—but no manufacturers—indicate they have committed significant resources to AI adoption, with only about 5 percent of service firms characterizing AI adoption as a major strategic investment. Among AI adopters, the median share of workers using it was just 17 percent for service firms and 7 percent for manufacturers.

In short, AI adoption in the workplace is now fairly broad but investments and worker usage remain limited.

With AI use in the workplace now widespread, why have some businesses refrained from adopting it?

(…) cost does not seem to be the main deterrent—it was among the least cited reasons by non-adopters. About half of non-adopters said the type of work they do does not lend itself to AI, while roughly a quarter indicated AI is currently not good enough to provide benefits to their business.

There were also some concerns about using AI. More than a third of non-adopters were concerned about data privacy, security, or confidentiality, and a similar share expressed concerns about accuracy or reliability. Further, roughly a third indicated they currently lack staff with the technical skills to use it effectively. (…)

Consistent with our earlier surveys, existing workers are much more likely to be retrained than replaced by AI. Among businesses that use AI, just over a third of service firms and more than 20 percent of manufacturing firms report retraining workers in response to AI. Firms report retraining workers across the educational spectrum, though somewhat more of those with college degrees.

These findings align with the broader research literature, which also tends to find limited labor market effects from AI adoption so far in terms of layoffs or reduced hiring. However, one recent study suggests entry-level workers may be affected significantly, as AI can substitute for routine tasks often performed by newer employees, potentially creating barriers to workforce entry even as it enhances productivity for experienced workers. (…)

Evidence from our surveys so far confirms what many studies are showing: that AI has been more likely to augment workers than replace them.

The most striking number in Dell’s release was that Dell’s AI-optimized server revenue came in at $16.4 billion, up 100% year over year. Crucially, the AI server business had a record $95 billion backlog as of the end of the second quarter. Companies are rapidly equipping for AI.

• AI Data Center Spending to Reach $32 Trillion by 2050, PwC Says

Global data center spending is set to reach $31.6 trillion through 2050 to meet the world’s growing appetite for AI, an investment boom with no precedent in history, according to PricewaterhouseCoopers LLP.

Dwarfing projects such as the railways, internet and electrification, spending on data centers could even hit $50 trillion over the next two and a half decades if AI adoption accelerates beyond PwC’s “central scenario” forecast, the firm said in a report Wednesday. For comparison: the US gross domestic product is roughly $30 trillion. (…)

The bulk of the spending will go into what fills the data centers — hardware from companies such as global AI chip leader Nvidia Corp. (…)

Spending will keep rising through mid-century as graphics processing units, servers, storage systems, networking equipment and other hardware will require routine replacement. Recurring chip upgrades — the computational power — and not land or construction, will account for most of the investment, quite unlike traditional capex cycles like prior generations of memory chip production or the global fiber internet rollout, which “front loaded” investments, taking on costs and risks upfront. (…)

On an annual basis, global data center spending will increase from about $800 billion this year to $1.1 trillion in 2030 and $1.8 trillion in 2050, PwC predicted. China and India will drive the largest share of incremental demand, supported by large populations, rapidly expanding digital economies, and substantial headroom for AI to embed in business and consumer activity. (…)

While global demand is strong, factors such as power availability, data sovereignty requirements and the flow of semiconductors will determine which regions capture the investments, PwC said. Power will be the foremost factor that shapes where AI infrastructure investment occurs.

Indeed, much of the forecast hinges on how fast reliable electricity supply for data centers can be established, according to the report. Affordable, reliable, and increasingly low-carbon electricity at scale is the hardest requirement for many markets to meet.

And while the researchers’ projection assumes a fairly open trading system where chips move freely across borders, disruptions in semiconductor supply chains could cut global investment by nearly 20%, they said. Meanwhile, a growing sovereignty push could redistribute, but not reduce, global investment.

“The $31.6 trillion question isn’t whether the capital exists. It does,” the researchers said. “Nor is the question whether the demand is real. It is. The question is which regions, operators, and institutions are positioned to capture it and which aren’t.”

Elon Musk Monday warned that the artificial intelligence industry is racing toward an imminent global power crisis, predicting a massive 15-gigawatt energy shortfall by 2027. Musk said that electricity has officially replaced chips as the primary bottleneck for AI development.

He revealed that AI deployment is growing exponentially at 40% to 50% annually, while power capacity outside of China is crawling forward at just 10% to 20% per year.

Without a rapid intervention in power infrastructure, Musk warned that billions of dollars in advanced AI processors will sit completely idle.

Musk noted that while China possesses substantial electricity infrastructure, strict GPU export bans limit their chip access. Conversely, Western tech hubs have the chips but lack the raw wattage to support them

I bet it will be easier for China to solve its chip problem than for the US its power challenges.

US manufacturing remains robust, but jobs market stays subdued

In terms of today’s US data, the August ISM manufacturing index is a touch softer than expected at 54.6 in August, down from 55.6 (consensus 55.2). The 50 mark separates expansion from contraction: the further the index rises above 50, the faster the pace of growth, while readings below 50 indicate contraction, with lower values signalling a steeper decline.

In terms of the details, the production index remains in very strong growth territory at 58.3, historically consistent with GDP growth of close to 3%.

New orders slipped to 53.7 from 56.7, the weakest reading since March, while employment moderated to 51.2 from 52.8, but remains clear of the 6M average of 49.6.

In general, the activity metrics underscore the improvements seen in the manufacturing sector, which is in large part a consequence of the surge in tech related investment spending.

The downside is the prices paid component remains very firm at 71.1, indicating input costs, such as energy, commodities and semiconductors, continue to increase at a rapid pace.

Overall, there is nothing in this report to moderate market pricing over a Federal Reserve rate hike later in the month – that currently stands at 16bp of a potential 25bp hike.

US ISM output metrics versus YoY GDP growth

Source: Macrobond, ING

• Solid improvement in business conditions masks slower demand and output growth as supply issues persist

The headline seasonally adjusted S&P Global US Manufacturing Purchasing Managers’ Index™ (PMI) was unchanged at 53.9 in August, signaling a solid expansion in the manufacturing economy. (…)

Manufacturers continued to build inventories of inputs and finished goods to guard against price increases and delivery delays, although another marked lengthening of average lead times hindered these efforts. (…)

New orders rose at a solid pace in August that was little changed from July. Growth was largely confined to the domestic market, however, as exports fell for the fourteenth month running. Tariffs were reported to have weighed on
foreign sales, although some firms noted that pockets of improved demand from Europe had partly offset this impact. (…)

Purchasing activity increased for the eighth month running, in line with increased production requirements. Where buying rose, firms also linked this to efforts to secure inputs ahead of further price increases and supply disruption. As
a result, pre-production inventories continued to expand, although the pace of accumulation was the softest since April amid difficulties receiving inputs due to material shortages and high prices.

These issues contributed to another marked lengthening of average lead times in August, with the latest deterioration among the steepest seen over the past four years.

(…) goods producers reporting broad-based increases in input prices linked to the war in the Middle East and tariffs. Manufacturing companies, in turn, raised charges at the slowest pace since February.

Canada: Growth maintained at solid rate as output, new orders and employment all rise

(…) Panellists reported that demand had improved since July, albeit predominately from domestic markets. New export orders fell for the third successive month, largely due to the ongoing negative impact of trade tariffs.

Helping to support the expansion of production in August was a solid rise in employment, with overall job creation the best since October 2024. Extra staff were generally hired to increase capacity and help deal with rising overall workloads.

Although growth was modest, backlogs of work nonetheless rose to the greatest degree since June 2022.

(…) purchasing and stock accumulation partly reflected pre-purchasing of goods due to worries over price trends and product availability.

On the price front, input cost inflation was again historically elevated, despite easing to a four-month low. Panellists principally attributed inflation to US tariffs, higher fuel costs and increased prices for metals like aluminium and steel. Where possible, costs were passed on to customers via an increase in output prices, although inflation also dropped since July.

Hurray for the Bond Market Higher yields aren’t yet a crisis. They could be if the politicians in Washington don’t listen.

(…) Spendthrift governments might finally have to pay more to borrow and tighten their belts as a result. (…)

Neither party in Washington is willing to reform the runaway entitlements that are driving the debt.

The bond vigilantes aren’t yet in full cry, but their early murmurs are welcome. They are sending a message to Washington and other Western nations to clean up their fiscal acts. Bond investors may be the only people who can force the politicians to pay attention. The real worry is if the politicians don’t listen.

Scott Bessent after the G-20 that he graciously kicked off mocking Canada gave the US government’s position on that:

“The world is awash in debt,” Bessent told reporters Monday at the gathering. “The only way for us to get out of this is to grow our way out of it.”

“With America once again leading this forum, the days of settling for subpar growth are over. The discussions we’ve had here this week leave me confident that many of our partners are now prepared to join us.”

Kevin Warsh, an avowed market listener, seems to think there are more than one way “out of this”.

Investors are now clear about the asynchrony between the Fed and the current administration.

Greg Ip about Bessent’s only way:

This is not a credible solution. First, growth hasn’t come to the rescue yet. U.S. GDP is up 2.1% in the past 12 months, in line with Joe Biden’s last year in office. The federal deficit is likely to top 6% of GDP this fiscal year, in line with or higher than in Biden’s last full fiscal year.

Second, an AI boom isn’t enough. In a recent paper, economists Doug Elmendorf, Karen Dynan and Louise Sheiner examined scenarios in which AI sustainably boosted annual productivity growth by a half to a full percentage point, with differing impacts on employment. In all scenarios, the debt keeps rising as a share of GDP, albeit more slowly than now.

Third, better growth naturally leads to higher interest rates, which raises the interest bill on the debt. Indeed, that may be one factor at work now. Heady visions of AI’s potential have uncorked a tidal wave of AI-linked borrowing.

Gavekal sums up this financial world:

(…) a world in which policy settings across the Western world will most likely stay the same (i.e.: profligate fiscal policies, monetary policies that stay behind the curve, trade policies that crush productivity and forward planning, and diplomacy which favors wars and conflict over peace and compromises).

US Diesel Hits Highest Since April as Wars Strain Global Supply

(…) Diesel is the lifeblood of the global economy, powering trucks, agriculture and construction, and spikes at the retail level affect industries as well as consumers. The fuel has been boosted this year by the conflict in the Middle East, as well as the Russia-Ukraine war. Moscow — typically a major supplier — has curbed exports following waves of attacks on its refineries. (…)

• Europe’s largest airline warns of jet-fuel prices at $140 this winter as it cuts capacity

(…) Jeff Currie, a well-established commentator on commodity markets and a senior advisor at the Carlyle Group, warned investors about refined products a few weeks ago. Interviewed by CNBC Aug 18, Currie emphasized that markets were looking at the wrong price: “Nobody on the planet consumes crude oil except refineries. Everyone else consumes gasoline, diesel and jet fuel and those markets look considerably uglier.” (…)

[Goldman’s trader] Privorotsky also warns that even if the U.S. now decides to “aggressively de-escalate” that “crude is just one component of the problem as distillate, gasoil, diesel and critically, European natural gas have all broken out.” (…)

• Energy price surge hits bond markets as European gas reaches three-year high

(…) “The perception that this [conflict] is all going to be over by Christmas is fading fast,” said Mike Bell, head of market strategy at RBC BlueBay Asset Management. “That’s driving the market.” (…)

Gas companies traditionally store up supplies over the summer months to smooth out any disruption over the winter, but this year stores are at their lowest level for more than a decade. Across the EU, stocks were only 63 per cent full in the last week of August. (…)

The supply crunch is also hitting

• LNG (20% of global trade through Hormuz)
• Fertilizers and chemicals (30%)
• Aluminum (9%)
• Methanol (30%), feedstock for resins, coatings and plastics
• Helium (30%), semiconductor manufacturing, MRI scanners.
• Sulfur (~50%), a feedstock for sulfuric acid, a chemical required for two global workflows: EV batteries, fertilizers.
• Graphite: EV batteries
• Glycol: key input for polyester fibres, packaging and textiles
• Iron ore/steel pellets
• Green hydrogen

(Yardeni Research)

Beware: September Is Back Again

Everyone in the stock market knows that September is the cruelest month for stocks. But when it is a bad month, it tends to create buying opportunities for a year-end rally that often starts in October. (…)

We share the Bond Vigilantes’ concerns, but we aren’t convinced bond yields are, or will soon be, prohibitively high. True, they are back to levels seen before the Great Financial Crisis (GFC). But that’s because they are normalizing after a long period of abnormally low bond yields following the GFC, when central banks were rigging bond markets.

Since the lows of the Great Virus Crisis, yields in the major overseas government bond markets have mostly recovered and converged to their respective national nominal GDP growth rates.

As we’ve recently observed, in the US, nominal GDP rose 6.6% y/y during Q2-2026, while the 10-year Treasury yield is 4.80% this evening. If it hits 5.00%, we expect strong demand for the bond, including from Treasury Secretary Scott Bessent. He’ll issue more Treasury bills to buy back bonds if necessary to avert a selling panic. (…)

• September is historically the toughest month for equities, with positive returns just 49% of the time. (The Daily Shot)

Renaissance Macro Research via EntryPoint by Sherwood

Historically, September’s worst S&P 500 declines have overwhelmingly occurred during already-weak markets.

Source: @RyanDetrick

Strong year-to-date gains have historically preceded many of the best September returns, suggesting the S&P 500’s nearly 13% advance in 2026 may reduce the risk of a sharp September selloff.

Source: @RyanDetrick