Lee also warned that further Fed rate hikes could worsen the divide between sectors that are benefiting from the AI boom and those already under pressure. He said the Fed risks being lulled into a false sense of confidence by the headline growth numbers while overlooking weakness in the real economy and labour market.
This is an edited transcript of the interview.
Q: The US markets continue to power on, hitting fresh record highs for the S&P 500, despite very elevated global yields. Overnight, they cooled off a tad, but compared to where they were a year or even six months ago, the US 10-year is at 5.3%. What explains this complete disregard, from an equity point of view, for what the bond markets are telling us?
A: Isn’t it amazing that the equity markets treat these bond yields as almost irrelevant. But then, of course, we’re focused on the artificial intelligence (AI) trade.
If you’re talking to any mortgage broker or anyone in the housing market, they are all bemoaning the fact that in the United States, the 30-year mortgage is now well over 7%, more like 7.3-7.4%, and there’s absolutely no sign of any recovery in the housing market. There’s absolutely no sign of any break that consumers will get in financing auto purchases.
So, I think the interest-sensitive sectors are in fact suffering, but because the US economy is growing so quickly and so strongly, it covers up a lot of these weaknesses.
And I must say, you ask the question, why are these interest rates so high? Well, there is a host of answers. The global issue of fiscal deficits being run away in places like Western Europe is one of them. But I think the real answer is the US economy is just growing very quickly, and the demand for capital is just amazing, especially when it comes to the AI trade. I think that’s really the heart of the situation in the United States right now.
Q: So even if we do get another Fed rate hike, perhaps two more, do you think that really slows down the US economy if demand is so strong and the AI capital requirements are high? They can easily absorb these interest rate hikes. So, will the interest rate hikes by the Fed be effective, if at all, or will they need more? How does this play out?
A: The interest rate hikes on the part of the Fed are going to be affecting the short- to medium-term interest rates, and those are the rates that small businesses are borrowing for inventories and for business expansion other than AI trade-related, and that’s where you see a lot of hurt right now.
The people who are doing very well are the owners of equity, but that’s only, again, 15% of the US population. Those who are dependent upon jobs in the interest-sensitive sectors, in housing, in construction — unless you’re working on a data center, you’re having a hard time finding a job in construction.
So, the US economy is showing a lot of cracks under the surface of this AI trade, and the Fed itself is recognising that the distribution of its policy impact is going to be very dicey because if it were to continue to raise rates, it’ll continue to affect the interest-sensitive sectors badly, and those places that are overheating will be completely left untouched, like the AI trade.
Q: Four weeks from now, we’ll have the US midterms. Who’s winning?
A: The betting market right now is so iffy. The odds are that the Democrats will probably take the House, but the Senate will probably remain Republican. But that’s a very uncertain and low-confidence, low-conviction kind of forecast.
I think the market’s reaction to whoever wins is going to be a good one because a split Congress and divided government is something that the markets have always favoured.
Government inaction means more possibility for the private sector to do stuff, and that’s really what is probably going to be driving the markets for the next two years.
Q: So, the split Congress, market goes up. An unsplit Congress, the market goes up as well, right?
A: You’re right. The AI part of the market will be going up regardless. By the way, keep in mind that when you look at the S&P 500, if you take away the AI-related stuff, about 80% of those stocks are underwater. They are doing very badly, and so the kind of October doldrums that we normally have associated with the volatility of October is there. It’s just that the broad indices are covering it up because the market caps of the AI-related stocks are so high.
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So, as I said, the US economy is not as good as things seem to be when you look at the markets. But I think because the Fed works in aggregates, the overall speed of 2.5-3% growth in the United States compared to less than half of that in Europe and elsewhere — those numbers are very impressive, and will lull the Fed into a false sense of confidence that we don’t need to worry about the real economy. We don’t need to worry about the labour market. We just need to nail that inflation number, and then we’ll be rewarded for doing that job. I think that’s a serious policy mistake.
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