Mortgage Rates And Falling Oil Prices | ITK With Cathie Wood

Key Concepts

• Rolling Recession: A recession affecting different sectors of the economy at different times, rather than a broad, simultaneous downturn.
• Productivity-Driven Growth: Economic growth fueled by increases in efficiency and output per unit of input, leading to potentially lower inflation.
• Regonomics: A blend of deregulation and economic stimulus, likened to “Reaganomics” but potentially more impactful.
• Twin Deficits: The combined impact of the US budget deficit and trade deficit.
• Yield Curve: The difference in interest rates between long-term and short-term US Treasury bonds, often used as a recession indicator.
• Unit Labor Costs: The cost of labor per unit of output, a key factor in inflation.
• Trueflation: A real-time inflation measure based on tracking tens of thousands of prices.
• AI-Native Generation: The current generation entering the workforce, characterized by inherent familiarity and comfort with artificial intelligence.

Economic Outlook & The Rolling Recession

The speaker begins by acknowledging the end of the government shutdown and transitions into a discussion of recent economic statistics, framing it as a preview of an upcoming research letter. The central theme is the concept of a “rolling recession,” which, despite positive headline GDP growth (4% in Q3, potentially 5% in Q4 according to Atlanta Fed estimates), is characterized by significant negative developments in specific sectors.

Housing Market Analysis

A primary example of this rolling recession is the housing market, severely impacted by the 22-fold increase in the Fed Funds rate from 0.25% to 5.5%. Housing activity has fallen to levels comparable to the late 1970s, despite a significantly larger US population (340 million now vs. 215-220 million then). The speaker notes President Trump’s recent focus on housing affordability, specifically the announced plan to purchase $200 billion in mortgage bonds to lower interest rates, but cautions that this amount is relatively small compared to the overall mortgage debt (trillions of dollars) and hasn’t yet significantly impacted long-term rates. However, a rebound in housing is anticipated, driven by falling interest rates, price cuts, and potentially policy interventions.

Manufacturing Sector Contraction

Another key component of the rolling recession is the prolonged contraction in the US manufacturing sector. The Purchasing Managers' Index (PMI) has remained below 50 (the expansion/contraction demarcation point) for nearly three years, an unusually long period of contraction. The speaker believes this sector is poised for a rebound as well.

Capital Spending & The AI Impact

The speaker highlights a leading indicator – non-defense capital goods orders – showing a breakout above a $70 billion baseline established since 2000. This breakout is attributed to the “AI moment” (ChatGPT and similar technologies). Prior to this, non-AI related capital spending was a drag on overall investment. The speaker anticipates significant further increases in capital spending related to AI and the necessary power infrastructure to support it.

Consumer Sentiment & Inflation Expectations

Consumer confidence, measured by the University of Michigan survey, is notably low, particularly among lower-income categories, reaching levels not seen since the 1980s. However, the speaker points out a potential bias in the survey methodology (a shift to online data collection resulting in a 70/30 Democrat/Republican split), suggesting caution in interpreting the data. Critically, consumers still expect elevated inflation (3-4%), but the speaker disagrees with this expectation, predicting a downward surprise in inflation.

The Inflation Call: Drivers & Expectations

The core argument is that inflation will fall due to several factors: declining oil prices (potentially down 20-25% with increased Venezuelan production), falling housing prices (both new and existing homes), and increasing productivity. Unit labor costs are also stabilizing, with productivity growth outpacing wage growth, a dynamic not seen since the 1970s. “Trueflation,” a real-time inflation measure, is already showing a decline below 2%. Furthermore, the speaker believes China is exporting deflation through increased production capacity and lower prices.

Policy Backdrop: Fiscal & Trade Dynamics

The speaker analyzes the US budget deficit, noting its decline from 17% of GDP during COVID to around 5% currently, though still above historical norms. Treasury Secretary Yellen aims to reduce it further to 3% by 2028. The trade deficit is also improving, with exports increasing and imports decreasing, contributing to GDP growth. This is partially attributed to tariffs and negotiations with other countries. The speaker challenges the conventional wisdom that trade deficits are inherently bad, arguing that they can be beneficial if the US economy grows faster than the rest of the world. The speaker emphasizes that spending cuts, rather than tax increases, are driving the deficit reduction, framing spending as a form of taxation.

Monetary Policy & Interest Rates

The speaker examines the yield curve (2-year Treasury yield minus 3-month Treasury yield), currently inverted (below zero), indicating tight monetary policy. Historically, an inverted yield curve has often preceded recessions, but the speaker suggests the current situation may be different due to the unique dynamics of this economic cycle. The speaker anticipates that interest rates will fall as inflation declines, potentially back into the 3% range.

Market Valuation & Productivity

The speaker discusses the S&P 500’s price-to-earnings (P/E) ratio relative to inflation, noting that valuations have risen as inflation has stabilized. However, the speaker believes that strong earnings growth, driven by productivity gains and innovation (particularly AI), will justify these valuations. The speaker highlights the resurgence of productivity growth, reaching 4.9% in the last quarter, and links it to investments in robotics, energy storage, AI, blockchain, and multiomic sequencing.

Bitcoin & Crypto Asset Diversification

The speaker touches on the rising price of gold and questions whether it reflects irrational exuberance. They then turn to Bitcoin, noting its low correlation with other asset classes, including gold, suggesting its potential as a portfolio diversification tool.

Final Outlook & Key Takeaways

The speaker concludes with an optimistic outlook, predicting a period of strong economic growth, low inflation surprises, and a “Goldilocks” scenario reminiscent of the 1980s and 1990s. They emphasize the importance of monitoring key indicators like oil prices, housing prices, unit labor costs, and productivity. The speaker encourages listeners to stay tuned for their upcoming research letter, Bitcoin/DeFi pieces, and “Big Ideas” report. The overall message is one of cautious optimism, driven by the belief that technological innovation and sound policy will lead to a period of sustained economic prosperity.