You know, it was a

great quarter for the economy, 3.4% annual rate, best in a year.

If you actually look under the hood, there are some measures of demand growing around 5%, best in three or four years.

It's an economy that's not just strong, but it's accelerating.

But Kai, the thing that I find striking is that if you actually look at the income side of the statement, you know, where's the money going that is basically being thrown off by this fast-growing economy? Real disposable income, the money that ordinary folks out there are holding on to after their taxes and everything like that, it's only growing around 1.5% after inflation.

That's half the rate of economic growth.

Why the difference? Because so much of this economic growth is investment.

And the markets now are getting a little bit uneasy about it, it sure seems like.

Economy's growing, but so are prices.

Yep.

You know, it was a great quarter for the economy, 3.4% annual rate, best in a year.

If you actually look under the hood, there are some measures of demand growing around 5%, best in three or four years.

It's an economy that's not just strong, but it's accelerating.

But Kai, the thing that I find striking is that if you actually look at the income side of the statement, you know, where is the money going that is basically being thrown off by this fast-growing economy? Real disposable income, the money that ordinary folks out there are holding on to after their taxes and everything like that, it's only growing around 1.5% after inflation.

That's half the rate of economic growth.

And the markets now are getting a little bit uneasy about it, it sure seems like.

What do we know about what Republican and Democratic candidates are promising in terms of solutions to this cost of living crisis?

You know, I think this is one of the great ironies of this midterm election is that even though everybody agrees that the cost of living is the number one issue on people's minds, there isn't a ton that anyone can do about it, regardless of who wins in terms.

Let's say for the sake of argument that Democrats have a very good night on Tuesday and they win control of both the Senate and the House of Representatives.

Well, what can they do about it? stop the war in Iran, because that is under our constitution, the purview of the president, and he will wage that war as he sees fit.

So you cannot snap your fingers and just pass a law saying, restore all the access to oil and gas in the Strait of Hormuz that we used to have before.

Or consider the role of interest rates, right? That is, in our system, the role of our independent central bank, the Federal Reserve.

President Trump did try very hard to pressure the Federal Reserve into lowering interest rates, even named his own candidate to run the Federal Reserve, Kevin Moore.

Do you see artificial intelligence as a uniting issue in a deeply divided economy?

And this is in your newsletter.

That's right.

Yeah, it actually wasn't in the journal this morning.

It was in a newsletter, which I hope you'll subscribe to, Kelly.

You know, anybody can subscribe for free.

But like what I'm trying to do is bring things to people's attention that they really ought to know.

And today, what I want folks to get used to the idea of is stop thinking about today's rates as somewhat high.

But I worry that, to quote Barry Knapp, that it's exacerbating the K in the economy, that high Fed funds rates... is reacting to demand for ai but in reality making financial conditions tighter and less affordable for a lot of the rest of small businesses and everyday americans

And Greg, um, can you remind us what this truce, truce covers and what's at stake? It's mostly about rare earth minerals, right?

Yeah.

Well, if you cast your mind back a little over a year when the trade war began, uh, the United States put very high tariffs, up to a hundred percent or more, on China.

China responded by restricting exports of certain criti-critical things like rare earths.

The truce that was arrived at in, uh, Busan, South Korea, basically said, "We'll pull back some of our tariffs.

They'll start r- uh, releasing those exports again," and that's where we stand.

That has now been extended for another couple of months.

Greg, can you just recap what's going on and what this means for, you know, the rest of us?

Hey, Amy.

Hello.

And Greg, um, can you remind us what this truce, truce covers and what's at stake? It's mostly about rare earth minerals, right?

Yeah.

Well, if you cast your mind back a little over a year when the trade war began, uh, the United States put very high tariffs up to a hundred percent or more on China.

China responded by restricting exports of certain critical, critical things like rare earths.

The truce that was arrived at in, uh, Busan, South Korea, basically said, "We'll pull back some of our tariffs.

They'll start r- uh, releasing those exports again," and that's where we stand.

Greg, so maybe we're overplaying how much could have come out of the G20, but what could have come out of it?

Yeah, fair enough.

I mean, it's been a long time since I think since the G7 or the G20 actually mattered for, you know, near term market developments.

I remember it may have mattered once back during the financial crisis in 2008, but not much since then.

So maybe we were asking too much.

But that said, I mean, bond investors are worried about a bunch of things.

Among those are inflation because of, say, oil from Iran and trade wars.

Greg, you agree with that?

And persistent inflation can spur the Federal Reserve to raise short-term interest rates, meaning investors might be able to get a better deal on a shorter time horizon.

horizon.So your expectations of what the Federal Reserve is gonna do with very short-term interest rates are a major, major factor in what investors think Treasury bond yields should be.

As an investor, one of the things they look at is, well, um, if I lock my money up for 10 years in this bond, as is what happens when you buy a bond, will I regret that if, for example, the Federal Reserve raises interest rates tomorrow, and then I'll wish that I had actually not locked up my money for 10 years when I could have waited and gotten a better interest rate? At the start of this year, there was a widespread belief that inflation would fall, and as inflation fell, the Federal Reserve would lower short-term interest rates.

But inflation did not fall, and in fact, after the war with Iran began, oil prices shot up, and that raised inflation.

So not only do we no longer expect the Fed to cut interest rates, some people think the Fed will raise interest rates.

So investors have looked at that information and said, "If I'm gonna buy a bond, I want a higher yield today than I did eight months ago."

Mm.

And I think they have limited patience for the types of fundamental policies which fix things in the long run, like reducing the deficit.

Where do you think things stand now?

Um, so I think that if you go back to the start of the year, you would sort of say there have been four things since then that have started to put upward pressure on long-term rates.

One is inflation's been stickier, so the Fed isn't cutting rates.

One is that, um, the, uh, corporate borrowing binge with AI is putting a lot of crowding out pressure up on yields.

A third one is Japan, of course, put- uh, moving to raise interest rates.

And the fourth, of course, is the deficit keeps getting worse.

Now, um, in fairness to Scott Bessent, the Treasury Secretary, three of those four things he can't do anything about.

I'm, I'm more, uh, inclined to think about some of the uncertainty that's out there with how the bond market is operating along with the Fed.

What was that? What is that?

So Kai, that is the interest rate that the government will be paying on 30-year bonds that were sold at auction today.

And the reason that matters, it's one of the highest rates.

In fact, I believe it is the highest rate-

Yeah

... that the government has said that it will pay on a newly issued 30-year bond in almost 20 years.

And I suppose that as taxpayers, that's the kind of thing that's gonna bother us because we owe, have a lot of debt, and every time these rates go up, it means we have to pay even more interest to service that debt.

Okay, Greg, why is this happening and what does it mean for the average American who is not focused on the bond market?

Okay, there's several reasons that long-term interest rates, which is what bond yields are, are going up.

First of all, I think there were a lot of hopes that the Fed could cut interest rates this year, but inflation has been sticky, and with the war in Iran pushing up the price of oil, nobody thinks that's going to happen.

So that's one factor.

Another is that we have this federal deficit, which is approaching...

It's actually topped $2 trillion this year.

The federal debt is approaching $40 trillion.

Mm-hmm.

We will get onto the debt in just a moment, but one imagines that what this is saying is, uh, contra, uh, Chairman Warsh, um, rates are gonna be higher for longer, yes?

Right.

So Chairman Warsh, chairman of the Federal Reserve, controls what we call the short-term interest rate, the rate that's charged on overnight loans.

Uh, but if you are taking out a mortgage or if you're a business that wants to build a factory, you care more about long-term interest rates, and those are set by the bond market, not by the Federal Reserve.

And that's why you should care about what these 30-year bond yields are and these 10-year bond yields are.

And in spite of the Federal Reserve not having raised interest rates in quite a while, those 10 and 30-year bond yields have been creeping higher all year long, and that reflects several things.

Number one, inflation is still kind of sticky.

Right.

We will get on to the debt in just a moment, but one imagines that what this is saying is, contra Chairman Warsh, rates are going to be higher for longer, yes?

Right.

So Chairman Warsh, chairman of the Federal Reserve, controls what we call the short-term interest rate, the rate that's charged on overnight loans.

But if you are taking out a mortgage or if you're a business that wants to build a factory, you care more about long-term interest rates.

And those are set by the bond market, not by the Federal Reserve.

And that's why you should care about what these 30-year bond yields are and these 10-year bond yields are.

And in spite of the Federal Reserve not having raised interest rates in quite a while, those 10 and 30 year bond yields have been creeping higher all year long.

right?

In, in other words, is he creating one?

Well, that's certainly what the markets seem to think.

I mean, look, Kelly, the thing that puzzles me about this whole, um, week is that there was a very strong economically grounded case not to raise interest rates this week.

Uh, but Warsh didn't make that case.

I mean, he talked about, "We are absolutely going to deliver price stability But we're not gonna raise rates.

And the connective tissue between these two tu- two sentences is completely missing.

And so I think part of this is that he does sincerely want to pull back the communication, pull back, pull back the guidance, let markets provide as unfiltered a view as they want.

Um, and, and do you think that that's something that's coming to the surface here? Is he trying in a way to, to take the Fed out of the picture in order to show that, yeah, like, that problem, um, needs to be addressed or, or dealt with by, by the fiscal side?

What does all that mean for the average American and how they're experiencing this economy?

Well, the average American is certainly still not able to get over the fact that prices, as we're saying, are up 25 to 30% from four or five years ago.

They keep hoping that prices will go down.

It doesn't happen, because typically prices don't go down.

That's called deflation.

It's very rare.

So you have that s- that sort of, like, level of unhappiness with the inflation that's been there honestly for quite a few years now.

Greg, help us understand what Warsh is saying here and what all this might mean for the next Fed meeting and their decision ahead.

What does all that mean for the average American and how they're experiencing this economy?

Well, the average American is certainly still not able to get over the fact that prices, as we were saying, are up 25 to 30% from four or five years ago.

They keep hoping that prices will go down.

It doesn't happen, because typically prices don't go down.

That's called deflation.

It's very rare.

So you have that s- that sort of like level of unhappiness with the inflation that's been there honestly for quite a few years now.

Greg, help us understand what Warsh is saying here and what all this might mean for the next Fed meeting and their decision ahead.

We-- It seems to me that we don't have that space now.

now.Well, I think it's absolutely correct.

I mean, with the size of the deficits we're running now, it's getting harder and harder to find ways to raise those funds.

Congress apparently doesn't want to raise taxes.

Congress apparently doesn't want to cut spending, so where in the world is the extra money gonna come from? But, you know, Kai, there's another risk here, which is that it's not just the inability of the Treasury or the Congress to respond to a crisis because it's so short of money.

What if the fiscal situation is itself the cause of the crisis? What if the Treasury itself is the cause of the crisis? I mean, what if people decide they're not gonna buy the bonds, or they're gonna demand a much higher return in order to buy the bonds?

But maybe everybody doesn't, so you keep going and explain it.

Well, like I said, we have to sell a lot of bonds to people, and those are people are not, uh, out there trying to do favors to us.

All right, from the headline of this piece, How Sky-High Deficits Threaten the Bond Market, how then? Explain, please.

Sure.

Well, we are running very large deficits.

The largest deficits... relative to GDP that we've ever run in peacetime on an ongoing basis.

And what that means in practical terms is that every year the Treasury has to come to Wall Street and say, we need to borrow $2 trillion by selling you Treasury bills and Treasury bonds.

And it is getting more and more challenging to sell that debt.

Somebody's got to buy it.

Explain that, please, and why it matters.

Hmm.

If I'm right, then there's no five-alarm fire here.

There's no case for raising rates this month.

I don't think there's much strong case for raising rates at all this year.

I'll just come right out and say it.

Um, now, does that mean they need to cut rates? No.

There's nominal GDP is very strong.

Greg, what about the, uh, the testimony this morning? What jumped out to you?

We're speaking with Greg Ip of the Wall Street Journal, talking about his story, "In New York and Britain, Socialism Is on the March." Greg, thanks very much for your time, and let's start by what is really driving this change in terms of, uh, a move towards socialism, especially with younger generations?

You know, I think until now, uh, socialism was almost more of a flirtation.

You might have heard the expression hipster socialism.

And if you had talked to some of these young, uh, sort of like, uh, followers of it, they would've said, "Oh, it's about, like, more fairness, more equity, like, uh, you know, a kinder, gentler market." ...

uh, a bigger safety net.

And I think there's part of that, too.

But I think what we're learning, Dan, is that we're also starting to see more of the tough inner core of socialism emerge, by which I mean much stronger government control of the economy, even ownership of the economy.

So how different, then, is this wave of socialism now compared to what we saw several decades before?

And with Stephanie Hughes, what's the what's your sense of the vibes?

So this is a good week to talk about vibes because there were two very important vibes in the markets, but they kind of cut in opposite directions.

The first vibe goes to artificial intelligence, AI.

Now, we all know there's been this AI boom that's been going on for years.

It's one of the reasons the stock market's been so strong.

But this week, we saw growing signs of nervousness that maybe it's too strong.

People were saying, oh, my gosh, look, open AI is going to delay their IPO.

Do you really think so? Because if you look at, not that this is a stock picking show, but if you look at Micron Technologies the other day, they blew the doors off their earnings.

And Greg, I was looking back and thinking how many different Wall Street Journal reporters might have covered him, and it, Alan Murray was the one at the helm in 1987.

Yeah, and, uh, David Wessel came after him.

Jake Schlesinger did that for a while.

I covered him for five, uh, uh, five years, yeah, and that was great fun.

I really enjoyed it.

I enjoyed covering h- the Fed as an institution.

I loved covering Greenspan as a person.

Um, everyone else seems to be suffering somewhat from these high rates.

Does it remain a weapon and a tool?

tool?I think that it does, Kelly, but I'll be humble and say I don't know what the magnitude is.

Now, as you say, about a month ago, the future was trading about $30 below the s- the, uh, physical price, which basically said that while the president can push sentiment into bearish territory in the financial market quite easily, it's harder to do that in the physical market where people actually have to buy and sell physical barrels of oil.

But I do think that the sentiment matters.

I mean, it matters to you and me, right? That's what we're talking about, the futures price today.

We're not talking about the physical price.

That, that kind of matters.

Uh-huh

Yeah, yeah.

But if you take out all the spending on data centers and all that stuff, you're somewhere between 0.5 and 1.5%.

And by the way, a lot of that AI spending isn't even on stuff we make here in the United States.

We import it from Taiwan and South Korea.

You look at the stock market, right? Almost all that run-up in the s- in the, uh, towards records in the last few weeks is led by the so-called Magnificent Seven or the other semiconductor stocks-

Right

... that are sharing in this AI glow.

So the aggregate numbers are being held up by this AI boom, or bubble if you wanna call it.

Yeah, yeah.

But if you take out all the spending on data centers and all that stuff, you're somewhere between 0.5 and 1.5%.

And by the way, a lot of that AI spending isn't even on stuff we make here in the United States.

We import it from Taiwan and South Korea.

You look at the stock market, right? Almost all that run-up in the s- in the, uh, towards records in the last few weeks is led by the so-called Magnificent Seven or the other semiconductor stocks-

Right

... that are sharing in this AI glow.

So the aggregate numbers are being held up by this AI boom, or bubble if you wanna call it, but everything else underneath the surface looks kind of like flat-ish.