Demand Destruction

We make some significant sector and asset allocation changes as we expect the mix of growth, and monetary policy, are on the verge of rebalancing.

In addition to the aforementioned changes in our sector and asset allocation recommendations, we made structural changes to the tables intended to make it easier to implement our sector and asset allocation.

· Did RMPs Lite the Semi Fire? The Fed liquidity injections through reserve management purchases likely contributed to speculative activity in equities, especially semiconductors and leveraged single-stock products. With regulatory liquidity requirements likely to loosen and the Fed showing signs of ending RMPs, aggregate liquidity may contract even as bank credit is redirected toward productive private-sector capital investment.

· Less Imbalanced Growth. The 1Q26 GDP revisions showed softer consumption and private domestic demand but even stronger nonresidential fixed investment, particularly intellectual property investment. We see the worst of the consumption slowdown as likely behind us, while warning that AI-related capex may remain a strong secular trend but is becoming more vulnerable to cyclical cooling and investor caution.

· Discounting Disinflation. Market pricing, especially the sharp decline in breakeven inflation and bull steepening in Treasuries, is increasingly signaling disinflation and a low probability of renewed Fed hikes. Policymakers should put more weight on market-based inflation signals, particularly as trimmed-mean PCE remains near post-pandemic lows, and the CPI/PCE divergence looks historically anomalous.

· Demand Destruction. We push back on the claim from some members of the FOMC that AI buildout is clearly inflationary, arguing that higher costs in one sector only become inflationary if fiscal and monetary policy accommodate them. Weakening share prices among major AI capex spenders, rising capital intensity, and signs of financing saturation suggest the buildout may instead pressure margins, compress valuations, and become disinflationary at the margin.