Apollo's Torsten Sløk on the 'very, very important issue' facing the US economy

Key Concepts

• AI Impact on Labor Market: The potential for Artificial Intelligence to significantly disrupt employment, leading to job losses and productivity gains.
• Affordability Crisis: The increasing cost of essential goods and services like housing, healthcare, and education, reducing disposable income.
• Federal Reserve Tools: The limitations of the Fed's monetary policy in directly addressing the affordability crisis.
• Fiscal Policy: The role of government spending and taxation in influencing prices and economic conditions.
• Inflation Mountain: The risk of a resurgence in inflation, potentially driven by economic growth and fiscal stimulus.
• Economic Growth Tailwinds: Factors like AI, fiscal policy (e.g., "one big beautiful bill"), and capital expenditure (capex) driving economic expansion.
• Market Rally: The current upward trend in the stock market, interpreted as a sign of anticipated economic acceleration.
• Politicization of the Fed: The concern that future Federal Reserve decisions might be influenced by political considerations rather than purely economic factors.
• Yield Curve: The relationship between short-term and long-term interest rates, and its potential steepening.
• Fed Dissents: Disagreements among Federal Reserve voting members, indicating a divergence in economic outlooks.

AI and the Labor Market

The transcript highlights a significant concern from Fed Chair Jerome Powell regarding the potential impact of AI on the labor market. While AI, particularly through large language models, is recognized for increasing productivity in daily tasks and business operations, its macro-economic implications remain uncertain. Powell noted that jobless claims are low and the unemployment rate has only slightly increased, with no dramatic productivity gains or unemployment spikes yet observed. However, he acknowledged that a substantial number of jobs, such as those in marketing and customer service (e.g., ordering at McDonald's via a screen), could "completely vanish." The degree of AI implementation and adoption rate, especially by 2026, is a key unknown factor, making the overall economic impact highly uncertain despite a generally positive outlook.

Affordability Crisis and the Fed's Role

The discussion delves into the issue of affordability and economic anxiety felt by many Americans. Economists define affordability by the rising prices of essential goods and services like education, healthcare, and housing, which now constitute a larger share of consumer spending. This leaves less discretionary income for other activities. The Federal Reserve's ability to address this crisis is severely limited. Lowering interest rates, for instance, could paradoxically increase home prices, exacerbating the problem. Therefore, the Fed lacks direct tools to lower the prices of these specific goods.

Fiscal Policy as a Solution

The responsibility for tackling the affordability crisis is largely placed on fiscal policy, involving Congress and the President. Potential solutions include:

• Reducing Tariffs: Lowering tariffs, particularly on food, could directly reduce prices.
• Subsidies and Tax Incentives: Providing subsidies or tax incentives for housing could make it easier for households, especially first-time homebuyers (whose median age is around 40), to enter the market. For example, offering $5,000-$10,000 in tax credits for home purchases.

The effectiveness of these measures hinges on Congress's willingness to implement them.

The Risk of an "Inflation Mountain"

The transcript warns of a potential "second inflation mountain," following the surge after COVID-19. This risk is fueled by several factors:

• AI-driven Growth: Increased productivity from AI could stimulate economic growth.
• Fiscal Stimulus: The "one big beautiful bill" is cited, which includes provisions for immediate expensing of capital expenditures. This allows companies to deduct 100% of new building or factory costs immediately from taxes, normally spread over years. This is expected to boost capital expenditure (capex), not just in data centers but across various business sectors.
• Economic Pick-up in 2026: These tailwinds suggest a potential acceleration in economic activity in 2026, which could lead to renewed inflationary pressures.

Market Rally and Economic Acceleration

The current market rally is interpreted as the market anticipating a late-stage economic boom and an acceleration in growth, particularly into the second half of next year. This bullish narrative is replacing earlier concerns about a slowdown. Key drivers include:

• Fiscal Policy: The "one big beautiful bill."
• Data Center Build-out: Significant investment in data centers.
• Consumer Spending: High-end consumers continue to perform well.

This shift from a growth slowdown narrative to an acceleration narrative is creating tailwinds for corporate earnings and potentially higher inflation.

The New Fed Chair and Political Risk

A significant risk identified for 2026 is the potential for the new Fed chair to lower interest rates purely for political reasons. This is particularly concerning because, despite the Fed signaling and implementing rate cuts since September 2024, long-term interest rates have not declined.

• Steeper Yield Curve: A new Fed chair pushing for lower rates could lead to an even steeper yield curve, signaling concerns about potentially higher inflation.
• Balancing Act: The new chair will face a difficult decision balancing high inflation (which suggests keeping rates high) with a weaker labor market (which suggests cutting rates).
• Ignoring Inflation: If the Fed chair prioritizes growth over inflation concerns, it could increase the risk of the "second inflation mountain."

Politicization of the Federal Reserve

The transcript expresses concern about the increasing politicization of the Federal Reserve. Evidence of this includes:

• Increased Dissents: The recent meeting saw three dissents: two against rate cuts and one for more aggressive cuts. This indicates a growing divergence in opinions among Fed members.
• Uncharted Territory: The potential for significant disagreements (e.g., 7-5 votes) in future meetings suggests the Fed is entering "uncharted territories" with less clear messaging, which could impact equity markets.

Conclusion

The discussion paints a complex economic picture characterized by the dual forces of AI-driven productivity and potential labor market disruption, alongside persistent affordability challenges that fiscal policy is better equipped to address. The risk of a renewed inflation surge, fueled by economic growth and fiscal stimulus, is a significant concern for 2026. The market appears to be pricing in an acceleration of growth, but the Federal Reserve's future actions, particularly under a new chair, and the potential for politicization, introduce considerable uncertainty and risk for investors. The increasing divergence of opinions within the Fed itself further underscores this evolving and potentially volatile economic landscape.