AI's Next Big Question: Will Future Cash Flows Justify Today's Investment Boom?

According to the Financial Times reporting,

"More than $9bn worth of CDS linked to bonds issued by Oracle, SpaceX, Alpha­bet, Amazon, Meta, Broad­com and Nvidia was traded on average each week in September, up from less than $2bn in July, accord­ing to Morgan Stanley Research. US cor­por­ate CDS index trading volumes this year have overtaken last year’s total, according to Bloomberg.

AI-linked debt issuance has rocketed with companies raising an estimated $466bn so far this year, up from $101bn in the same period in 2025, according to Morgan Stanley, to fund infrastructure such as data centres and chips.

Five-year Meta CDS has this month climbed to 108 basis points, meaning it costs $108,000 a year to insure $10mn of debt against default, while derivatives tied to Nvidia have climbed to 101bp. Protection against Alphabet and Amazon default is also at record highs.

Oracle’s CDS is now 322bp, up from 144bp at the start of the year. The five-year CDS tied to CoreWeave debt is trading at about 1,090bp, with demand so high that a buyer of $10mn of pro­tection would need to pay $1.82mn upfront."

My Take:

This is an interesting piece of information because it suggests that the broader market is becoming more aware of potential credit risks associated with the massive AI investment cycle. While increased CDS activity does not necessarily imply that defaults are imminent, it is an important data point because many financial crises have historically begun with credit events that later cascaded through the broader financial system.

Make no mistake, AI is here to stay. That is not the question. The FT article signals to me that investors are beginning to ask a question that has surfaced during many investment booms: Will the future cash flows generated by these enormous investments ultimately justify the amount of debt and capital being committed today?

Demystifying GDP: What 10 Years of Data Reveal About Spending, Investment, and Global Capital Flows

When news outlets report on economic health, GDP is almost always the start of the show. We often hear that it grew by 2% (we are richer) or that it shrank by 1% (we are poorer), treating it like a single national scorecard. Yet, beneath that single headline number lies a simple but helpful formula that helps explain how an economy functions, who is investing, and how a nation interacts with the rest of the world.

By looking at the GDP equation alongside a decade of data from the FRED database from 2016 to 2026, we can uncover an interesting story about modern economic life, including why a “negative” trade balance isn’t simply a loss, but a reflection of global capital flowing across borders.

The Anatomy of an Economy: The GDP Equation

At its core, GDP measures the total market value of all finished goods and services produced within a country over a specified time period. Economists commonly track GDP using the so-called expenditure approach, which breaks economic activity into four distinct buckets:

GDP = C + I + G + (X – M) 

Here is what each component represents:

• Consumer Spending (C): Everything households purchase.
• Business Investment (I): Capital to build future productive capacity.
• Government Spending (G): Spending by local, state, and federal government (excludes social service spending).
• Net Exports (X – M): What we sell to other nations minus what we purchase from abroad.

A Decade in Numbers: What the Data Shows (2016 – 2026)

Let’s examine the historical time series of the U.S. Real GDP (adjusted for inflation, measured in chained 2027 dollars) between 2016 and 2026:

Here is another view of the data:

Key Observations:

• The Consumer Remains the Engine: Consumer spending consistently makes up about 70% of total GDP.
• Investment and Government Share the Remaining Domestic Slice: These categories together account for approximately 35% of GDP.
• Net Exports Have Consistently Run Negatives: The Net Exports category has remained below zero across the entire 10-year span. The trade deficit expanded from approximately 3% of GDP in 2016 to 5% in 2026.

Demystifying the Minus Sign: Are Imports a “Drag” on GDP?

A persistent misconception in popular commentary is that because imports are subtracted from the Net Exports formula (X = M), running a trade deficit reduces or destroys economic growth. Let me give a simple example to show why that is not the case.

When an individual buys a $1,500 imported television, the full $1,500 is immediately added to Consumer Spending (‘C’). However, that television was produced abroad, not domestically. Because GDP only measures domestic production, the accounting system subtracts $1,500 under Imports (‘M’). Therefore, the calculation balances out: +$1,500 in C + -$1,500 in M = 0 (net change to GDP).

Subtracting imports is simply an arithmetic correction to ensure foreign-made goods counted in side C, I, and G are not falsely credited to domestic factories.

The Real Meaning of Negative Net Exports: Borrowing from the World

When an entire country buys more goods and services that it produces, it must finance the difference through capital inflows from abroad. This brings us to one of the most fundamental relationships in macroeconomics: the Saving-Investment Identity:

National Saving – Domestic Investment = Net Exports

When Net Exports are negative (a trade deficit), it directly implies that Domestic Investment > National Savings. This means that the country does not have enough domestic savings to fund all private investment and government borrowing; as a result, it must obtain capital from abroad. Foreign exporters who earn dollars selling goods do not simply stash those dollars away. Instead, they reinvest them back into the domestic economy (e.g. purchasing government and corporate debt, or acquiring productive assets).

Viewing trade through the lens of capital flows gives us a far more balanced perspective. Accessing global capital flows allows the U.S. to invest in capital at higher levels than domestic savings alone would support. However, persistent capital inflows (trade deficits) increase foreign claims on future domestic income, whether through interest payments on debt or dividends and asset returns sent to foreign owners.

Having said that, it is worth pointing out that whether a trade deficit is beneficial or harmful depends largely on how the associated foreign capital is used. Capital that finances productive investment can enhance future growth, while capital that primarily supports consumption or persistent fiscal deficits may create long-term vulnerabilities.

Furthermore, while the saving-investment identity shows that trade deficits are associated with domestic investment exceeding national saving, economists debate the direction of causation. Some emphasize insufficient savings, others point to attractive investment opportunities that draw foreign capital, and others focus on monetary conditions that encourage borrowing and spending.

Conclusion:

The GDP formula is more than an abstract equation; it is a live mirror of national economic choices. The past decade of data illustrates an economy anchored by high consumer spending and supported by investment levels that exceed domestic savings, something which has been made possible by a global financial system that continues to supply the necessary capital. A key systemic risk is the disorderly reduction in capital inflows without a concomitant increase in savings, which could lead to a severe economic contraction. This is no speculation. It is a possibility and something we should be mindful of.

Upstream Pressure, Downstream Reality: What the CPI vs. PPI Gap Means for Corporate Profits and the Economy

This past week we read about the headline Consumer Price Index (CPI) and how it compares to the Median CPI (read my post here). Here in this note, I will explain what the CPI says with respect to the Producers Price Index (PPI). The PPI tracks the wholesale selling prices received by domestic businesses.

Comparing the CPI and PPI provides a view into corporate profit margins, business pricing power, and the inflation pipeline. The latest economic data reveals a significant divergence: wholesale costs are rising much faster than retail prices (PPI at 6.3% vs. CPI at 3.7%). This gap points to an upstream supply shock that is currently squeezing corporate profit margins rather than fueling an economy-wide boom.

The Mechanics: What the CPI vs. PPI Relationship Tells Us

To understand how inflation moves through the economy, economists monitor the “spread” between what consumers pay and what producers receive as a rough proxy for the pressure on corporate margins:

Profit Margin Proxy Spread = CPI – PPI

When the CPI is greater than the PPI (Positive Spread):

• Consumer prices rise faster than wholesale input costs.
• Businesses have high pricing power and can easily pass on costs.
• Result: Corporate profit margins expand.

When the PPI is greater than the CPI (Negative Spread):

• Wholesale input costs rise faster than consumer prices.
• Businesses face resistance when attempting to pass higher costs on to consumers.
• Result: Corporate profit margins are squeezed.

While the CPI-PPI spread can provide insight into pricing power and margin pressure, it should not be viewed as a direct measure of corporate profitability. Labor costs, financing costs, productivity trends, and industry-specific factors also influence profit margins.

In addition to serving as a profit margin proxy, the PPI acts as an early-stage inflation pipeline: changes in wholesale costs often influence consumer prices with a lag, although the timing and magnitude vary considerably (some believe it often takes 3 to 6 months for them to filter into consumer prices). Although the CPI and PPI do not measure the same basket of products, the important observation is that they are directionally related.

What the Latest BLS PPI Report Shows

The latest release from the U.S. Bureau of Labor Statistics highlights a dramatic surge in upstream costs:

• Annual Surge: Over the last 12 months, the PPI for final demand jumped 6.3%, the fastest 12-month advance since December 2022.
• Monthly Acceleration: In September alone, the final demand prices increased 1.3%, the fastest 12-month advance since March 2022.
• The Energy Driver: Over 80% of the goods increase was driven by energy costs, which jumped 10.8% in a single month (led by a 20.3% spike in gasoline).
• Underlying Core Wholesale: Even after stripping out food, energy, and trade, core PPI rose 5% over the last year, indicating that wholesale cost pressures are broad across the industrial supply chain.

Interpreting the CPI vs. PPI Spread Chart

Courtesy of ZeroHedge, we obtained the following graph:

Let’s analyze the big picture of where we are in the economic cycle. When the CPI is greater than the PPI, you see a positive spread (green bars). When the PPI is greater than the CPI, you see a negative spread (red bars).

• 2015 – 2016: Strong corporate profit margin expansion (green bars, CPI > PPI)
• 2021 – 2022: Massive supply shock / corporate profit margin squeeze (deep red bars, CPI < PPI)
• 2023 – 2024: Corporate profit margin recovery (green bars, CPI > PPI)
• 2025 – Present: Sharp negative plunge to -2.6% (red bars, CPI < PPI)

Key Takeaway: The current deep red bars demonstrate that this is a classic supply/cost shock. Businesses are currently absorbing a substantial portion of higher wholesale energy and logistics costs rather than passing 100% of them immediately onto consumer price tags.

Conclusion

Federal Reserve monetary policy has a delicate balancing act to perform, because it cannot pump more oil or clear transport bottlenecks. Aggressive interest rate hikes to curb inflation could have the knock-on effect of choking off business investment and hiring, which will heighten recession risks. The risk is a type of self-fulfilling prophecy: in attempting to prevent inflation from becoming entrenched, the Federal Reserve may tighten financial conditions enough to contribute to the very recession it hopes to avoid. My view is that the Federal Reserve is likely to continue following its stated guidance and respond to persistent inflation pressures with additional gradual interest rate hikes.

If wholesale costs remain near 6.3% for multiple quarters, businesses will be tempted to eventually pass these higher costs through to consumers to protect corporate profit margins, which could push the CPI higher in 2027. 

Why an October Rate Hike Appears Increasingly Unlikely

According to the Financial Times reporting,

“Federal Reserve chair Kevin Warsh has signalled that hotter-than-anticipated inflation has not swayed his views on the US economy, prompting traders to further scale back bets on a rate rise this month…Bets on a rate increase climbed to as high as 55 per cent following stronger than expected US inflation figures on Wednesday before edging back. They fell further after Warsh’s comments, declining from around 27 per cent to around 15 per cent on Friday [October 16], according to Fed funds futures.”

In other words, it is highly unlikely that the Federal Reserve is going to hike rates at their next meeting on October 28. Although we are told that the Federal Reserve is independent, the fact is that, like all human beings, members of the Federal Reserve committee responsible for monetary policy are subject to influence. Barring a major economic surprise, I suspect that the proximity of the U.S. Congressional elections on November 4 reduces the likelihood of a rate increase at the October meeting. The last thing the Federal Reserve likely wants to do is draw attention to itself just days before an election, as its actions could be interpreted by some as favoring one group over another.

Having said that, I fully agree with Goldman Sachs’ economists that:

“’[a]longside other recent comments from FOMC participants, Warsh’s comments indicate that the FOMC is set to pause in October,’ economists at Goldman Sachs noted, adding they expect officials to raise rates at the Fed’s final meeting of the year in early December.”

In my view, the question is not whether rates will rise, but whether the Federal Reserve chooses to wait until after the election before taking further action. I think they will wait.

Decoding U.S. Inflation: What Headline CPI vs. Median CPI Tells Us About the Economy

The U.S. Bureau of Labor Statistics published the September 2026 Consumer Price Index for All Urban Consumers (CPI) on October 14, 2026, showing that the index “increased 0.6 percent on a seasonally adjusted basis…after rising 0.4 percent in August…Over the last 12 months, the all items index increased 3.7 percent before seasonal adjustment.”

That increase is modest, yet it could lead some observers to conclude that inflation pressures are once again broadening across the economy. However, to better understand whether inflation is truly broad-based, it is helpful to examine the Median Consumer Price Index, which is calculated by the Federal Reserve of Cleveland. By comparing the 12-month headline CPI rate against the 12-month median rate, we can clearly determine whether price pressures are widening across ordinary household purchases or confined to a few outlier categories.

We accessed the St. Louis Fed FRED database to construct our graphs.

 

We show the headline CPI (solid blue lines) by cumulative price change over the preceding 12 months, landing at 3.7% in September. With respect to the Median CPI, it measures the middle (50th percentile) price change across all consumer categories. The Median CPI (green dash lines) currently stands at 2.8%. This data transformation allowed us to establish a like-for-like comparison. 

Historical Context at a Glance

Three periods stand out:

1. Jan-2021 to Mid-2022: Both Headline CPI and Median increased in tandem. This meant that inflation was pervasive and widespread across every sector of the economy, and that prompted aggressive rate hikes by the Federal Reserve.

2. Mid-2022 to Late 2024: CPI dropped rapidly, as the supply disruptions during COVID subsided; but Median CPI remained elevated, consistently running above Headline CPI. That dynamic meant that core domestic expenses took longer to cool, creating inflation “stickiness” that kept the FRB on hold.

3. Mid-2025 to Early 2026: Median CPI steadily broke lower, with both metrics converging on average around the 2% - 3% range.

Conclusion:

As shown by the latest data, Headline CPI has ticked up to 3.7%, which gives the impression that inflation is heating up again. However, the Median CPI remains anchored at 2.8%, which suggests inflation is not presently exhibiting the type of broad-based acceleration characteristic of a new inflationary cycle. The latest data does not yet support the conclusion that the economy has entered a renewed inflationary cycle. Of course, things can change rather quickly, but when it comes to an inflationary phase, we are not there right now.

Locking In Treasury Yields: Opportunity or Premature Optimism?

According to a recent Financial Times article, investors are increasingly buying US Treasuries as yields climb toward levels not seen in decades. The rationale is straightforward: many investors believe rates may not rise much further, making current yields an attractive opportunity to lock in income. With inflation expectations remaining relatively stable, real Treasury yields have risen to around 3%, a level that many portfolio managers view as compelling.

One aspect of the article that caught my attention was the graph showing the sharp rise in US real yields since 2021:

While many investors appear to interpret current yield levels as attractive, the chart itself does not clearly indicate that real yields have reached a ceiling. In fact, the trend over the past several years has been upward. If real yields continue to rise, it would suggest that nominal interest rates are increasing faster than inflation expectations. Such a development could indicate the presence of structural forces supporting higher interest rates. However, the chart itself does not identify the source of those forces.

A second observation concerns the argument that financial stress, particularly in Europe, could lead to capital flows into US Treasuries. This logic is understandable. During periods of uncertainty, investors often seek the perceived safety and liquidity of the Treasury market. Increased demand would tend to push Treasury prices higher and yields lower. However, it is also worth considering whether a future economic slowdown or sovereign debt concern could simultaneously increase government borrowing needs, adding more Treasury supply to the market. The eventual direction of yields may depend on which force proves stronger.

For that reason, the most interesting question raised by the article may not be whether current Treasury yields are attractive. Rather, it is whether investors are correctly assessing the longer-term forces influencing interest rates.

Conclusion:

If inflation moderates and risk aversion rises, today's buyers may be locking in attractive returns. If structural forces continue pushing real yields higher, however, today's yields may prove less attractive than they currently appear. On balance, I believe the risks are tilted toward higher yields. Time will ultimately determine which view is correct, but the debate itself highlights just how important the Treasury market has become to the broader investment landscape. 

What Does It Mean When Private Equity Sees Global Financial Crisis-Level Opportunities While Markets Appear Calm?

According to the Financial Times, 

"Dipan Patel, co-chief executive of UK-headquartered buyout group Permira, told the FT Private Capital Summit in London this week that deals cut after the dotcom crash and global financial crisis were ‘among the best’ ever. ‘We're right back there today,’ he said."

Patel's comments caught my attention because they suggest that private market valuations have become unusually attractive, comparable in some respects to opportunities seen after the dotcom crash and the Global Financial Crisis.

While this does not necessarily imply that another crisis is imminent, it does raise an important question: Why are experienced dealmakers finding opportunities today that remind them of periods following major market dislocations?

If private market opportunities are indeed becoming comparable in some respects to those seen after prior market dislocations, while the broader financial markets continue to function with relatively little visible stress, we should consider whether underlying economic and financial risks are greater than generally perceived. At a minimum, Patel's observations may suggest that pockets of stress are developing beneath the surface, even if a broader crisis has yet to emerge.