AI Disruption and Monetary Policy
The Gang of Four Money Marketeers has the outlook all wrong; the front end is sending a clear signal rate policy is restrictive.
This week’s note argues that Fed policy is distorting capital allocation: restrictive short rates combined with a large balance sheet suppress long-term yields, channeling cheap financing into AI while squeezing Main Street. Inflation and wage growth are cooling, and the labor market is weaker than headline data suggest, supporting a move to neutral rates and aggressive balance sheet reduction. The larger macro risk is unsustainable government spending and rising debt, which reinforces the need to end debt monetization. In equities, growth remains concentrated in AI beneficiaries, and the Bessent monetary policy rebalancing is on hold pending Warsh’s confirmation, leading to a tactical shift toward technology, reduced financial exposure, and a small defensive allocation.
Monetary Policy
The policy rate is restrictive, but the large Fed balance sheet is suppressing long-term yields by ~50–75bp.
This mix is distorting capital allocation, favoring large AI borrowers while tightening conditions for small businesses and banks.
Yield curve signals policy is too tight.
Recommended path: cut rates to neutral, ease bank constraints and reserves, reduce the size and duration of the balance sheet.
Inflation
Disinflation trend intact; CPI components are cooling.
Shelter inflation likely to decline further through 2026.
Tariffs have been largely disinflationary (demand drag).
Government spending was the primary cause of the three post-war inflation shocks; slower spending growth is contributing to disinflation.
The inflation outlook supports a neutral policy stance.
Employment
Labor market is weaker than headline data suggest.
Payrolls were revised down significantly; job growth slowed sharply in 2025.
Wage growth is decelerating, suggesting demand is weak.
Employment gains are concentrated in healthcare, with low wage pressure.
Alternate Indicators point to soft labor demand, not stabilization.
Government Spending & Debt
Near-term spending growth has slowed to ~2%, but the CBO forecasts long-term outlays to rise to ~24% of GDP.
Persistent primary deficits and rising interest costs will cause federal debt to grow faster than the economy.
The outlook assumes no meaningful reform to mandatory spending (especially healthcare) or above trend capital investment and productivity growth.
Policy implication: The Fed should shrink its balance sheet and avoid debt monetization to restore market discipline on fiscal policy.
Equity Sector Changes
Technology: Increased (25% → 27.5%) on AI strength and improving revisions.
Financials: Reduced overweight (20% → 17.5%) due to yield curve headwinds and weak regional bank profitability.
Consumer Staples: Added a small 2% position.
Cash: Reduced (12% → 10%).