Weakness in Chinese investment is spreading

Benchmark revision shows less worrisome US inflation

Recent increases in US long-term rates surprisingly little impacted by inflation expectations

Even with strong capex, US nonfinancial corporations are generating more cash than they are investing

Investor sentiment worldwide is positive, especially in AI-led Asia

Sectoral shift in US job openings

Meteoric rise in AI-related semiconductor exports fueling South Korea's export boom

Regional Fed surveys showing further manufacturing acceleration in August

Sharp drop in China demand for oil helping to limit impact of Middle East conflict on the price

Decades high real price of copper posing physical challenge to investment boom

Rising US long-term real yields point to strong demand for investment funding

US retail sales accelerate even as consumers remain gloomy

Retail gasoline price still well above pre-conflict level and now rising again

PMIs showing widespread revival of global economy

Crude oil price has returned to pre-conflict level but traffic through Hormuz still subpar

Surging orders for computers and electronics propelling durable goods orders

Next year's inflation forecasts are on the rise and above target

Disrupted global supply chains placing upward pressure on US goods prices

Construction of data centers has overtaken transportation construction in US

Elevated energy prices putting intense upward pressure on input prices around the globe

US is big leader in global surge in private AI investment

Larger-than-usual income tax refunds this year are supporting consumer spending

Sharply rising share of AI-related jobs

Inflationary impact of surge in oil prices larger in Europe than in the US

Futures market thinks the price of oil will recede significantly over the next six months

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Andrew Cates

The AI boom faces a problem beyond the technology itself: its prospective customers must be able to afford it. Investment in computing capacity is adding to demand for power, equipment and capital before comparable productivity gains have spread across the economy. If those pressures weaken customers’ spending power, they may also constrain the revenues needed to justify the build-out. AI can fulfil its technical promise while disappointing those who finance it.

This helps explain why weakness outside technology should concern technology investors. The immediate beneficiaries of infrastructure spending are easy to identify. The eventual returns depend on a much broader group of businesses earning enough from AI to pay for its services. Those two stages need not proceed at the same pace.

**The costs arrive first**
Every investment boom creates demand before it creates productive capacity. For AI, the timing matters because several essential inputs are slow to expand. Power stations, grid connections and transformers take years to deliver. A well-funded buyer can secure priority without increasing what is immediately available to everyone else.

Electricity makes the constraint tangible. Data centres add demand to networks already serving competing needs. Fuel prices, weather and available generating capacity also matter, so rising power costs cannot simply be attributed to AI. Nevertheless, the build-out can intensify local shortages. For other users, the consequences include higher operating expenses and delays to investment, even if they have yet to adopt the technology.

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Finance adds another hurdle. Infrastructure must earn enough to cover depreciation and the cost of capital as well as operating expenses. Wider technology credit spreads suggest greater scrutiny of that calculation. Broader corporate spreads have remained comparatively stable: evidence of a general AI-driven credit squeeze is still lacking. The immediate concern is that substantial commitments are being financed before their customer revenues are secure.

**The customer must earn a return**
For an adopting business, the relevant calculation extends beyond the subscription. Integration, training and organisational change require money and management time. The savings or additional sales must justify the full cost. A company facing weak demand or pressure on margins has reason to proceed cautiously, negotiate harder or defer spending.

There is encouraging evidence of diffusion. Reported AI use among US businesses rose from below 18% in January to almost 24% in early October. But adoption often remains confined to a limited range of functions. Growing use does not yet establish how much customers will spend, or how profitable that spending will be for suppliers.

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Productivity growth and subdued unit labour costs leave room for optimism. Benefits may already be emerging. The uncertainty concerns their breadth and timing relative to the capital committed. Strong orders within the infrastructure supply chain cannot indefinitely substitute for returns earned by eventual users.

**The test for markets**
The potential feedback is therefore clear. An investment surge puts pressure on scarce inputs. Some prospective customers face higher costs before enjoying the savings. Their caution then constrains suppliers’ pricing and revenues, just as those suppliers must service a larger capital base. This is a vulnerability to test, rather than an established explanation for recent market weakness.

The financing outlook could make that test harder. Blue Chip forecasts envisage Aaa corporate yields above 6% through much of 2027 while nominal GDP growth slows towards 4.5%. This comparison is no direct measure of corporate profitability. It nevertheless points to a less forgiving environment for projects whose returns arrive late.

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The decisive evidence will be measurable savings for users and sustained cash generation for providers. Those gains would strengthen customer spending and validate the infrastructure. Weak margins and disappointing monetisation would expose the gap between investment commitments and the income available to support them. AI’s capabilities may be extraordinary. Its financial returns still depend on customers with the means and incentive to pay.

AI’s Costs Are Arriving Before Its Benefits

Charles Steindel

State labor markets were little-changed in September. New Jersey and South Carolina recorded statistically significant increases in jobs, while Wisconsin saw a decline (though the Brewers sweeping the Dodgers is likely providing great solace). Five states saw significant drops in their unemployment rates (Florida, Maryland, Nevada, New Hampshire, and Pennsylvania), though none was larger than .2 percentage points. The highest unemployment rates were in DC (5.6%), Oregon (5.1%), California (5.1%), Oregon (5.0%), and Michigan (5.0%). However, Oregon’s rate was not regarded as statistically higher than the nation’s 4.2%.Nebraska, New Hampshire, Hawaii, Vermont, North Dakota, and South Dakota had unemployment rates under 3.0%, while South Dakota’s 2.0% was the lowest in the nation.

Puerto Rico’s unemployment rate increased to 6.2%, reflecting another marked increase in the island’s labor force (July saw a .8% rise), while the island’s job count fell 1,500.

State Labor Markets in September 2026

Paul L. Kasriel

The Treasury released its monthly September 2026 and Fiscal Year (FY) budget data on October 16, 2026. As expected, it showed that interest on the debt exceeded national defense expenditures in FY 2026 and that as a percent of net Treasury receipts, interest on the debt reached 19.5%, the highest at least since 1940. Given the amount of marketable Treasury securities that have to be refinanced in the next three years, not to mention additions to the outstanding stock of Treasury securities due to persistent budget deficits, and given the current and expected level of interest rates, interest on the debt is on track to continue to grow absolutely and relatively. The Treasury is borrowing more and more just to pay the interest on its debt. With an upward-sloping Treasury yield curve (the yields on longer-maturity Treasury securities are higher than those on shorter-maturity issues), Treasury Secretary Bessent is shortening the maturity of outstanding Treasury securities by issuing new short-maturity debt and funding the buyback outstanding longer-maturity debt with short-maturity debt in an effort to mitigate the interest expense on the public debt. But if the Federal Reserve were to increase the federal funds rate in an effort to lower the inflation rate, this would frustrate Treasury Secretary Bessent’s plan. If the Federal Reserve were to reach an “accord” with the Treasury to keep the federal funds rate artificially low, the increase in interest on the public debt could be mitigated. This would be debt default by another name – higher inflation.

Let’s look at some data. Plotted in Chart 1 are the fiscal year observations of net interest payments on federal debt as percent of net receipts of the Treasury (the blue bars) and the monthly observations of the average interest rate on Treasury marketable interest-bearing debt through September 2026 (the red line). In FY 2026, net interest on the federal debt was 19.5%, the highest in decades. The last time interest as a percent of net budget receipts approached FY 2026’s level was in the mid 1980s through the late 1990s, when the average interest rate on marketable debt was considerably higher than it was in FY 2026. For example, the average interest rate on marketable Treasury debt in September 1991 was 8.058% as interest in relation to net receipts was 18.4%. As of September 2026, the average interest rate on outstanding marketable Treasury debt was only 3.518% while interest as a percent of net receipts was a full percentage point higher than it was in FY 1991. Obviously, the reason for this is that there is a much larger outstanding stock of federal interest-bearing debt.

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Because the federal government will be running deficits for as far as the eye can see, the amount of outstanding federal debt will continue to increase, which, unless interest rates should fall precipitously, means that interest expenditures on Treasury debt will continue to increase. But let’s leave increases in the outstanding Treasury debt aside and look at just the amount of debt that has to be refinanced in the next three years.

Plotted in Chart 2 are the quarter-end percentages of outstanding Treasury marketable debt that is maturing in the next 36 months (the blue bars) and the outstanding stock of Treasury marketable debt (the red line). At the end of 2026:Q3, 55% of the outstanding $31.831 trillion of Treasury debt or $17.507 trillion is maturing and, barring a fiscal miracle, will have to be refunded. Again, this is just the amount of debt that will have to be refunded. Again, barring a fiscal miracle, there will be additional new amounts of debt to be sold because of expected persistent budget deficits.

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So, there is a lot of Treasury debt that needs to be refunded in the next three years, not to mention the increasing amounts of debt to fund future deficits. (By the way, the FY 2026 federal budget deficit was $1.99 trillion). What is the interest-rate outlook for refunding the debt maturing and the new debt that has to be issued to fund the coming deficits? It is higher than the current average interest rate on outstanding marketable Treasury debt. Plotted in Chart 3 are the monthly observations of the average interest rate on outstanding marketable debt (the black bars), the end-of-September 2026 levels of the one-year Treasury security rate (the blue line), the implied one-year interest rate one year ahead (the red line) and the implied one-year interest rate four years ahead (the green line). As you can see, all of these interest rates, actual or implied by the current yield curve, are considerably higher than the current average interest rate on outstanding Treasury marketable debt. This suggests that budget interest expenditures are going higher not only because of additions to the outstanding debt but also because of higher interest rates on refunded debt.

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Perhaps this interest-on-debt “cancer” could be put into remission by paring future budget deficits? Perhaps. But tax increases have become the “third rail” of politics in this country. By the way, if the AI hype pans out, future tax revenues will be adversely affected because, under our current federal tax system, capital-derived income is taxed at a lower rate than labor income. If AI results in lower employment, labor taxation will be reduced. If we are politically unable to raise taxes, perhaps we can pare spending. Chart 4 speaks to the difficulty of slowing federal spending. As the chart shows, in FY 2026, as a percent of total net federal budget outlays, combined Social Security and Medicare expenditures, interest expenditures and national defense expenditures accounted for 37%, 14% and 13%, respectively. These three categories add up to 64% of total net federal expenditures. In the coming years, all three of these categories are expected to increase in absolute terms. If the federal government were to seriously contemplate cutting Social Security or Medicare benefits, there would be a “roll” on Washington, D.C. of senior citizens in their wheelchairs. Then there are Veterans’ benefits, which would be politically (and morally) difficult to slow. Perhaps Homeland Security outlays could be slowed if we reduced the number of ICE agents and their unmarked side-swiping vehicles chasing undocumented residents who have not been charged with any criminal offenses (much less convicted) or who are following the asylum rules under which they were admitted into the US. The Big Beautiful Bill will result in Medicaid savings by making it more difficult for low-income households to qualify for benefits, but there are political limits here, too.

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Because all of our federal debt is denominated in US dollars and, via the Federal Reserve and the banking system, we can “print” US dollars, I suspect and fear that we will try to inflate our way out of this debt “disease”. After all, we measure many of our federal budgetary metrics as a percent of nominal GDP. By creating more inflation, we can create more nominal GDP, the denominator of most of our budgetary-measurement fractions.

We are not the only nation that faces fiscal challenges. France has been in the news lately regarding its fiscal problems. Most of Europe, including the UK face fiscal challenges, in part because of aging populations and the budget expenditures related to retirees. Income equality and stagnant living standards are plaguing Europe and the US. This is creating social unrest. Witness the recent street protests in France, Italy and Spain. Regrettably, there is little fiscal “headroom” to address these challenges. Quoting a British diplomat who had served in China in the 1930s, “May you live in interesting times.”

Interest on the Public Debt Is a Metastasizing Budgetary Cancer

Viewpoints: June 2024

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