The challenge for the volatile AI sector is interest rates. Companies, be they hyperscalers with free cash flow or Neoclouds that will become free cash flow positive once the bulk of their buildout is complete, are borrowing money to fund CapEx as they attempt to maintain corporate control.
Selling stock dilutes the ownership of the current shareholders whihc they do not like. Further, when selling stock, they give away the big upside. Owners would prefer to give away some return in exchange for holding on to the upside. While the goal of using borrowed money is to increase returns, the problem is that financial leverage increases return volatility. That is all fine and dandy when the stock price is moving up. It is painful when the stock price takes a breather and gives back some (or, in the worst case, all) of the previous gains.
The debt markets are having trouble these days for reasons we have discussed for some time. The abuse of the financial markets during the C19 lockdown was extraordinary. Only an academic, politician, or establishment economist would tell you that increasing the money supply by printing $6 trillion on an already bloated $4 trillion would not cause price inflation. Any independent economist who is perfectly happy not working for the government or the Fed would tell you that monetary inflation always results in price inflation.
Adding insult to injury, they told us that shutting down production by forcing everyone to stay home would not affect prices, as we would get the items we need from overseas. This tale should tell you there is no such thing as Fed independence. The Fed did what it is mandated to do: print money to buy government bonds and suppress interest rates at a time when the Federal Government decided that fiscal irresponsibility was the adult thing to do.
Very predictably, there was an initial bout of price inflation whihc was nowhere as large as we expected. By increasing the quantity of high-powered money by 125%, it is only a matter of time for prices to rise, oh, something like 100% over the following 5 to 10 years. Real economic growth spends up some of that money, while productivity enhancement in the private sector absorbs a bit more. In our view, high inflation is expected for the foreseeable future. We think the market is finally coming around to our point of view and repricing long-duration assets (i.e., growth stocks). As a result, we will see these stocks sell off for a while as they reprice in the new interest-rate regime. We do not expect a bear market, as higher inflation eventually results in higher revenue and profits offsetting the short-term effects of a higher cost of capital.
In today’s note, we want to revisit price inflation and some of the price indexes, as we think they contribute to what we are seeing in the market overall.
Macro Crosscurrents Rattle the UST Yield Curve and Equity Valuations
- The PPI pressures signal more trouble even as the combination of CPI and PPI news saw the UST curve lower, with the 10Y UST now under 5.0%. The FedWatch odds of tightening by the Dec FOMC meeting to 400-425 bps are now at 69%. The odds for the Oct meeting are just 10.0%.
- Equity pain in tech can be one factor in a flight to quality, moving UST. Still, there is potential for investors to factor in how slow growth could start to spill into fixed-income investment expectations, as well as consumer resilience. Both have proven very resilient to this point. The assumption is that the needle can move.
- The higher YoY “Final demand” PPI inflation cuts across both goods and services, with Total Final Demand PPI at +6.3%, Final Demand Goods at +9.8%, and Final Demand Services at 4.9%, with all three higher than August YoY.
- Intermediate goods and services PPIs are also trending the wrong way, making it tougher to spin the long-term effects of war. War always causes prices to rise as resources are diverted from civilian to military use, and the government is not a price-sensitive economic actor.
Reading the PPI release is like going to the gym. It is a good idea even when you want to skip it, given the strain. There are a lot of tables and small fonts. The September 2026 PPI release was more interesting than usual, with the UST curve lower, stocks weaker in recent days, and price action coming at a time when inflation is rising, deficits are ballooning, and the AI ecosystem and broader tech valuations are facing some second-guessing.
The chart details the PPI headline final demand from November 2010 through September 2026. The trend line tells its own story, with PPI today posting 6.3%, triple the median level from 2010, when the market was in the middle of Obama’s first administration.
Back in 2010, ZIRP was the Fed’s monetary policy that continued through December 2015. That came after markets emerged from the worst of the financial crisis in 2009. As the rebound continued off the June 2009 lows, PPI hit 4.5% in September 2011 as the sovereign crisis was also cresting. We then saw another small peak in July 2018 at 3.4%, before the post-COVID inflation wave that led to the 2022 peak.
For Sept 2026, today’s “worst since 2022” PPI headlines tell the story.
The above table updates some key PPI lines for September 2026. The trend is virtually all bad. PPI for YoY “Final demand total” ticked up to 6.3% from 5.4% in August. “Final demand goods” (29% of PPI index) YoY rose to 9.8% from 7.7% last month. “Final demand services” (68.3% of the PPI index) moved to 4.9% from 4.5% in August. “Final demand energy” rose to 35.4% from 24.4%. That is ugly (and it sure is not Zelensky’s fault). We also highlight a few intermediate demand headline indicators at the bottom of the chart, and that’s bad news too.
The sequential MoM moves are a “follow the bouncing ball” and scan exercise, and the ball is clearly bouncing the wrong way in September from August. Both “Final demand goods” and “Final demand services” show material increases. Energy is another notable MoM pain point, moving from 4.5% to 10.8%. “Final demand core” posted a MoM move from 0.2% to 0.7%
Overall, if you see PPI as a leading indicator, macro pressure on inflation and/or costs (and thus margins) remains high. Pricing power is an industry-by-industry, goods-vs-services drill-down exercise. As 3Q26 earnings continue to roll in, the market will hear updates on various cost pressures, particularly energy and, to a lesser extent, materials.
These thoughts come from Macro4Micro, edited by the editors of The Options Edge.
We do not expect the rise in rates and oil prices to cause a long-term bear market in equities. That said, we see these factors causing a repriceing that will take the price down in the short run or hold flat for a year or two.
Here is something to think about. The US economy is less sensitive to oil than it used to be for several reasons. 1) Manufacturing is a smaller part of the economy than it was in the 1970s. That said, we think this is bad for wealth creation and national security, and we would like to see much more manufacturing in the US. 2) Oil was a major source of energy used to make electricity in the 1970s. That has shifted to natural gas whihc is very inexpensive. 3) Cars are more energy efficient than they used to be. and 4) this is the big one. The US produces all the energy it consumes. In the 1970s, money left the economy for the Middle East, Latin America, and Indonesia, reducing the economy’s purchasing power. Now, the higher prices are paid by people and companies to US companies, so the money and purchasing power stay in the US. It is not a net negative. It just raises the price of manufacturing and living.
In the final analysis, we think the economy rebalances in the short run, setting itself up for a better time ahead in the long run.
