OnePoint BFG CIO Warns: Bond Market Is Underestimating Inflation Risk

TechFlow Summary: While everyone stares at CPI data, this CIO points out that PPI has consistently exceeded CPI by about 200 basis points, with real inflation pressures quietly building up. For crypto investors, interest rate expectations directly dictate the pricing of risk assets. This article is a must-read.

Two Stock Markets, Two Economies

Can stocks and yields rise simultaneously? Peter says yes and no.

He says we are in a diverging economy and a diverging stock market.

"For stocks that have already stalled, those unrelated to AI data center construction, it's crucial," Peter says. "But for financing AI data center builds, it doesn't matter. We have two stock markets, two economies. If you're tied into that construction boom, everything is fine. If you aren't, you face greater challenges due to higher cost of capital, higher diesel and gasoline prices, and strain on middle- and lower-income consumers."

As noted on Just the Facts on YouTube:

Given this divergence, Peter says investors really need to "lift the hood and look clearly" in this environment. "Looking top-down makes it easy—U.S. growth is fine at 2%," he says. But given the reality of two stock markets and two economies, "investors need to ignore those macro pronouncements and figure out what's actually driving things."

Some sectors are in clear downtrends, simply masked by aggregate data. Peter asks: "Is it large-cap stocks pulling back to align with weakness elsewhere, or are the weakest sectors—the stocks outside of AI trades, catching up? Obviously, we hope for the latter."

Then there's the ripple effect of AI trades on unexpected companies: "Delta Air Lines specifically addressed client wealth effects during its earnings call on Friday," Peter says. "CEO Ed Bastian talked about how this extra wealth made people feel rich enough to spend, fueling this experience economy. Delta isn't an AI stock, but it indirectly benefits from AI trades pushing up the broader market."

Another example is banks, whose capital markets businesses have seen substantial revenue driven by trading activity and financing demands stemming from AI trades.

The AI Trade: China vs. U.S.

But even within the AI trade, conditions aren't entirely rosy. Peter flagged ChangXin Memory Technologies (CXMT), Micron's Chinese competitor, which went public earlier this year. "Bloomberg reported that CXMT is rolling out a new chip capable of storing more memory," he says. "Micron's stock peaked in June, right before CXMT's IPO, which is hardly a coincidence."

Additionally, Peter says, "Anyone long Western Digital or SanDisk should look into Yangtze Memory Technologies (YMTC), the Chinese company producing NAND flash. It will go public at some point, likely in early 2027."

"Then, of course, there are the various low-cost Chinese models and the continually falling token prices," Peter says. "And all of this is unfolding ahead of Anthropic's potential IPO."

💡 "I'm tossing all of this your way because of the AI trade's dominance in the market and its contribution to economic growth; everyone should have a dashboard to monitor these factors," he says. "Think of it like a dashboard in your car—it flashes a red light when something goes wrong. I'm not saying we'll jump straight from green to red; perhaps yellow lights will blink first."

🪢Peter wrote more about this on his Substack this morning.

The Real Estate Slump

Peter says the housing market has been in a recession for some time, with existing home sales hitting a 30-year low.

Mortgage rates for 30-year loans exceeding 7% have created a "freeze effect," Peter says. "You're starting to see home prices drop in certain markets, which I actually think is a good thing. The key to housing affordability is needing a period where home prices fall as much as possible, or at least stagnate, while incomes continue to grow steadily." This gives buyers time to save for down payments without missing out on further appreciation, Peter adds: "If home prices in certain markets were to decline more sharply, it would help cushion the impact of rising mortgage rates."

If you already own property, none of this is particularly good news, Peter says: "But if you don't plan to move, you don't need to worry too much about fluctuations in your home's value. The crux of the housing market lies in creating affordability for first-time buyers. Without them, the entire market gets clogged up."

The Inflation Narrative

"I implore everyone not to assume the CPI tells the whole story of inflation," Peter says. "The complete picture includes PPI, which has consistently run about 200 basis points above CPI. Assume CPI drops to 2%, but PPI sits at 4%. Has the Fed finished its job? If corporations are enduring a 200-basis-point squeeze on profit margins from inflation, have they met their mandate? No, they haven't."

The Fed will tell you "they need to suppress demand to offset the supply constraints we're seeing," Peter says. "If supply pressures are driving prices up, then we raise rates to cool demand. That's the only way to rebuild some equilibrium. But it's a game of chicken with the real economy, because if you overdo it and damage the economy, you violate your labor market mandate… It's an extremely difficult situation."

Bond market segments are "essentially blown out," Peter says, pointing out that if you bought 30-year Treasuries in November 2020, you're now down 53% mark-to-market.

"Fixed income, particularly sovereign bonds, has taken a massive hit," he says. "We're starting to see early signs of stress in the lower tier of the corporate bond market. We're beginning to see the impact of rising risk-free rates hitting corporations."

That said, Peter notes that when he saw the cover of The Economist, he thought, "Well, maybe yields have topped in the short term."

"I still believe yields will continue to trend higher over the next few years, but in the short term, they may have seen their peak," he says.

💡 "I'm not long the long end," he says. "I still find the short end attractive—solid returns without taking on interest rate risk. And I find TIPS very appealing because I believe the bond market is underpricing the average inflation rate over the next five years as I see it."

The Energy Play

While energy is naturally caught up in the AI trade, Peter still views it as a strong diversification tool since it involves much more than just AI.

"I think oil prices will remain elevated, and oil and gas companies will perform exceptionally well over the coming years," he says. "We've gone long on several plays, believing oil will stay 'higher for longer'… There's still a market assumption that oil will revert to the $70s to low $90s range, and everything will normalize. Maybe. But I still believe oil will stay high for a considerable time, even if the war ends today, because normalizing inventories alone takes 18 months to two years."

Thanks to RF, Charles Pace, and everyone watching live! We'll continue Talking Markets tomorrow (Wednesday) with Dale.

Disclaimer: This article is for informational purposes only and does not constitute investment advice. Please consult a qualified financial advisor to assess your risk tolerance, investment objectives, and overall financial planning.

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