The day after a rate hike, the 10-year yield traded down seven basis points, to 4.93% (more curve flattening). Stocks rallied. Technology led.

We’ve talked often about the parallels between the current environment and the late 90s boom.

And this rate hike yesterday gives us another point of comparison.

As we know, a technology revolution was underway in the late 90s, with the rapid adoption of the internet. Productivity was high. Growth was hot. Inflation was tame (relatively low). And the Fed juiced it with rate cuts, starting in 1995. 

The stock market boomed in 95, up 34%.  And up another 20% in 1996. The economy boomed, growing 3.8% in 1996, up from 2.7% in 1995.

Then, in March of 1997, Alan Greenspan raised the Fed Funds rate a quarter point, to 5.5%.

The reason the committee gave, in its own words: “persisting strength in demand, which is progressively increasing the risk of inflation imbalances developing in the economy that would eventually undermine the long expansion.”

They hiked because the economy was strong and they were worried about what that strength might eventually do.

Compare that to what Warsh said yesterday.

He was asked how a quarter point helps when it can’t reopen the Strait of Hormuz (i.e. a quarter point hike can’t fix the oil supply disruption). Warsh said, the Fed can’t affect any individual price, but it can “ensure that any change in relative prices don’t broaden out, don’t have second and third order effects.” This is another, Greenspan-like hike based on what prices might eventually do. 

Same argument, twenty-nine years apart.

So, what came next after the hike in 1997?

For eighteen months the committee pushed Greenspan to hike again as unemployment fell toward 4% and growth boomed. The Fed’s models said that had to produce inflation. He refused, and told them why: information technology was raising productivity, raising the economy’s potential growth rate, and unemployment could fall further than anyone thought without prices rising.

He was right. Inflation actually fell. 

Still, the Fed held rates steady at 5.5%. But not just steady, at real rates (Fed Funds rate minus inflation) between 3% and nearly 5% — very restrictive policy.

None of it stopped the boom.

The economy averaged 4.6% quarterly annualized growth through the end of the decade. Stocks put up five consecutive double-digit years, averaging 26%. And inflation moved lower (not higher). 

It turns out, the productivity gains from the tech revolution were more powerful than the Fed’s restrictive policy. 

Through those years, American productivity growth averaged about 2.7%.

Fast forward to today: since the release of ChatGPT in late 2022, it has averaged 2.5%.

The Fed Funds is now at 3.75% to 4%, against 5.5% then. And the real rate, after yesterday’s hike, is positive, but at just 0.18%, against roughly 3%+ then.

So, we have a productivity rate that rhymes with the late 90s.

A policy rate nowhere near as restrictive as the one that the 90s boom absorbed without breaking stride.

And the AI-driven tech revolution is bigger than the internet. 

The Fed raised rates today.

So, the tightening that the bond market already delivered, as we discussed, didn’t deter them.

And the hike was a unanimous 12-0. Warsh even led the statement with that signal of unanimity (after July’s 9-3 hold). 

How did the bond market respond?

The 2-year Treasury yield opened at 4.65% and closed at 4.73%. The 30-year closed a touch lower, around 5.36%.

That’s short end up, long end down.

That’s a flattening yield curve. That’s the Fed putting pressure on future growth.

Let’s talk about Warsh’s press conference.

The first question in the Q&A was well placed. A journalist in the room pointed out that a quarter point rate hike does not reopen the Strait of Hormuz. That addresses directly the point we made going in. You don’t hike rates into a supply shock. In this case, it does nothing to bring down the price of oil. 

Warsh agreed. And this is where the rate hike was framed.

He said the Fed cannot affect any individual price, but what it can do is “ensure that any change in relative prices don’t broaden out, don’t have second and third order effects.”

So he conceded the tool doesn’t fix the problem, and hiked anyway to prevent the problem from spreading.

What would make it spread? A strong economy.

On that note, Warsh called the economy strong and strengthening. 

So, this was a hike to slow growth. This, from a Fed that Warsh said has “an attitude of optimism.” Presumably, that means the Fed is confident that the economy can absorb a quarter point hike.  

That said, the old Fed takes a growing economy out back and shoots it.

The Warsh “mental model,” as we’ve been told, is that you don’t push demand down to respond to a supply shock. And you don’t hike rates to slow an economy running hot on productivity gains. Hot productivity is the cure for elevated inflation. 

The Fed decides tomorrow.

The 10-year Treasury yield closed at exactly 5% today. As we discussed yesterday, that’s the level that stopped the Fed in October of 2023, when Powell looked at a 5% long bond and told the New York Economic Club that financial conditions had “tightened significantly.”

The bond market had done the work. He stopped the tightening cycle, and within two months the 10-year was under 4%.

Kevin Warsh made the same observation himself in July, in his own press conference: “we haven’t done much in 42 days. The markets have done quite a bit.” He’s talking about the rise in longer term bond yields. 

That said, the market says he hikes tomorrow. The bond market has given him reason not to.

Now let’s talk about something bigger than the Fed meeting — the AI doom campaign.

Remember, it was just twelve days ago, OpenAI released its GPT-6 model.

Three days later, the man running the most valuable, and most important company in the world, said this about it …

AGI is “Artificial General Intelligence.” GPT-6 itself defines it as “AI that can learn, reason, and solve problems across a broad range of tasks at roughly human level or better.“

And this is the stage where the AI begins to autonomously improve itself, which creates a path to “superintelligence” — AI far beyond human capabilities.

Now, after this marinated a few days, one of the great hedge fund traders of our time, Paul Tudor Jones penned an op-ed in the Wall Street Journal sounding the alarm on AI safety. 

Was he talking his book? Very likely. 

By Saturday, the two leading frontier model CEOs were calling for a slow down on AI model development.

The media and politicians have since amplified the case.

But keep in mind, AGI has been declared by the man who sells the chips that AGI will need in unlimited supply. Meanwhile, the margin of performance between the frontier models, as measured by the third party Artificial Analysis Intelligence Index, is extremely tight.

Notice the cluster of the top models circled in the graphic below. This has GPT-6 leading, but at a level well below the performance reported from OpenAI’s internal tests.

So, the American labs continue to lead: OpenAI, Anthropic, Google. But the Chinese labs, DeepSeek, Alibaba, Kimi, and others, have continued to compress the gap.

Until proof of AGI, the frontier is still converging.

And the consequences of who ends up on top are massive.

As we’ve discussed over the past eighteen months, whoever gets to human-level intelligence first sets the standard. They attract the talent. They decide what gets embedded in governments, in banks, in power grids, in weapons. It’s the difference between AI that serves humanity and AI that serves the Chinese Communist Party.

You cannot slow down in that race.

We get the Fed decision this week.

The ECB raised rates last week, into an energy supply shock-driven inflation number, and European yields have since risen (benchmark German 10-year yields). The euro has fallen. And risk premiums in Europe widened on the move.

Why? Because increasing borrowing costs will do nothing to lower the cost of energy in Europe.

Still, the ECB is sending signals to markets that more rate hikes are coming. 

As for the Fed, the market is now pricing in a hike this week, and as many as two more by March.

As we’ve discussed, the new Fed, under Warsh, is not about giving the market signals. As Warsh has said, he wants the markets to “play the ball, not the referee.”  

That said, the market knows the old Fed playbook. And Warsh sits at the table with old Fed loyalists. So the market reads three dissenters at the last meeting (who favored a July hike) as signal.

And with that, the U.S. 10-year Treasury yield has been marching higher and traded above 5% today, for the first time since 2023.

Let’s talk about that 2023 episode. 

It was October of 2023 when the 10-year yield tested 5%. The Fed, under Powell, was holding real rates high, and they surprised markets by sending a more hawkish signal in their September meeting — even as inflation was falling.

In response, the 10-year yield started a 64 basis point climb toward the 5% level.

Stocks traded down 5% as rates headed toward 5%.

Mortgage rates traded to 23-year highs.

Investment grade corporate bonds were at one-year lows. 

And at the time, oil had made a 40% surge in the third quarter, up to $95, driven by war in the Middle East. And with that rate and energy market dynamic, in October the Bank of Japan was forced to intervene in the currency markets to defend the value of the yen. 

Sound familiar? 

It turns out the 5% level in the benchmark bond yield was financial stability kryptonite — enough to flip the switch at the Fed.

Just weeks after setting the bond market repricing into motion, Jerome Powell delivered a prepared speech to the New York Economic Club and said that financial conditions had “tightened significantly” since their September meeting (i.e. long-term bond yields).

Translation: If the Fed needed to do more, the bond market had done it for them (and maybe too much). It signaled the end of the tightening cycle.

The reprieve in the bond market was immediate. And within two months 10-year yields were trading under 4%.  

And keep in mind, inflation (both headline and core) was in the mid 3% area (similar levels to now). And Powell backed off the tightening policy path as inflation expectations were, at that time, much higher than current levels. 

 

So, three years ago the bond market did the tightening and the Fed took the excuse.

This week the market expects a hike. But the bond market has again done the tightening, and has given Warsh an excuse to hold. 

Moreover, Warsh doesn’t think you raise rates into a supply shock. He has said that pushing down demand (through higher policy rates) until it meets supply is “not my mental model.”

Add to all of this, Warsh said in his Senate confirmation hearing that he prefers the Dallas Fed’s “trimmed averages” to measure inflation. That number was 2.3% in July. That would put real rates around 150 basis points, which is about the level of October 2023 (policy rates – trimmed mean PCE).     

The European Central Bank raised interest rates this morning, to 2.50%.

The decision was unanimous. It was expected.

Let’s go through what Christine Lagarde said in the press conference, because she spent the time making the case against her own decision.

Asked to explain the framework, she described the situation in Europe as “predominantly a supply shock.” Exactly. Europe has an energy problem, not a demand problem.

Then the monetary policy statement said this: wages do not show a material response to the energy shock at this stage. Compensation per employee grew 3.3% in the second quarter, down from 3.5% in the first. Unit labor costs slowed to 2.6% from 3.5%.

And on food prices, steady at 1.2%. 

So, Lagarde says it’s a supply shock. No wage pressures. Falling unit labor costs. No second round effects visible anywhere in the data.

And yet the ECB delivered a unanimous rate hike.

Now remember what Scott Bessent said from Asheville two weeks ago: “traditionally, you don’t raise into a supply shock unless you see second or third order effects.”

So, the ECB ignored that, and ignored its own history of policy mistakes under similar conditions.

Meanwhile, a reporter in the room pointed out that the ECB’s own June adverse scenario for energy prices assumed European gas at €60.

They moved the goalposts on the macroeconomic projections report they released today. They now see €60 as the baseline scenario for European gas. The adverse scenario assumed €77 and the severe scenario is at €130.

Gas is now at €82 — already above the adverse scenario.

That’s growth destructive, and the scenario analysis does not factor in tightening by the ECB (which they did today).

Now, what’s also interesting in this report, they didn’t model a problem in the sovereign debt market.

They talked about risk sensitivity to these scenarios in corporate bond spreads, bank equity, bank bond spreads, lending spreads, but nothing on sovereign debt vulnerability.

So, if the gas price shock becomes severe, the ECB seems to want the market to believe that their standing threat to backstop the fiscally fragile sovereign bond markets in Europe will be sufficient (such, that it’s not even worth discussing in the report).

But as we’ve discussed for much of the past year, the ECB backstop only works when major global central banks are coordinating (namely the Fed is behind you). And the Warsh-led Fed is unlikely to be there, unless political conditions are met (alignment). 

The European Central Bank decides on rates tomorrow morning.

The interest rate market has fully priced in a quarter point hike for weeks.

A hike in December is also fully priced in. And a hike is priced in for March.

So, that’s 75 basis points of tightening expected over the next six months to respond to a rising headline inflation number. Meanwhile, core inflation in Europe — inflation excluding food and energy — is falling. It’s 2.4%. 

A hike tomorrow would be the second quarter point hike since June. That would further destroy demand in an economy that’s barely growing. And of course the inflation isn’t demand-driven anyway, it’s supply-driven — it’s an energy price shock.

As you can see in the chart below, Dutch natural gas traded to €80 per megawatt hour today. That is 2.5x higher than where it sat the day before the strikes. And it’s a new high for this war.

 

An energy price shock of this proportion is plenty to destroy demand in the eurozone economy. And the ECB is about to pile on.  

With that, let’s take a look at two other episodes where the ECB raised rates into an energy shock.

In July of 2008, euro area inflation was running 4%, the fastest in sixteen years, driven by soaring energy prices. Meanwhile, the financial system was wobbling from an unraveling financial crisis. The Fed had cut rates a few months earlier. Oil prices broke $145 a barrel. The ECB hiked rates in response to energy prices and fear of a wage spiral. 

Within six months, the ECB had cut by 175 basis points.

They did it again in July of 2011. Greece was already in its first bailout, Trichet raised for the second time that year. Same reasoning. Energy prices and the fear of a wage spiral. The Fed and the Bank of England both stood still.

Within months, the ECB was forced to cut, again.

So, that’s two hiking cycles into energy shocks. Two reversals, both inside a year, and not because the economy was performing well. 

The interest rate market isn’t reflecting this history (pricing in two more hikes, after tomorrow), nor is the stock market (benchmark German stocks), which was at record highs just 9 business days ago.

We open the week with more kinetic action around Kharg Island. And oil (WTI) is back in the mid $90s. 

Remember, on August 30, the President posted a video of Kharg Island exploding. It was a fake video made with AI. A week later he posted a second one, captioned “Bye bye, Kharg.”

This past Saturday, explosions were heard near the island again.

And today, more sounds of explosions. Oil goes up. 

Let’s revisit the importance of this island.

It sits twenty miles off the Iranian coast. And it handles over 90% of Iran’s oil exports.

And keep this in mind: On March 13, we destroyed more than ninety military sites on Kharg in a single raid, but left every piece of oil infrastructure standing.

Six months later, that remains the case. The oil infrastructure is all intact.

Why?

You don’t destroy the asset you intend to take.

As we’ve discussed, Trump has been talking about taking Iranian oil since 1987, when he told Barbara Walters that America should go in, grab one of their big oil installations, and keep it.

In 1988 he named the island to The Guardian. In March of this year he told the Financial Times his favorite option is to take the oil in Iran, and on the 30th he suggested seizing the terminal outright.

Which brings us to what happened in Caracas last week. It’s the next stage in the Venezuela model we’ve been discussing. 

On January 3, the United States captured Maduro in a military raid and took control of Venezuela’s oil exports. On August 28, Trump announced American majority control of more than 65 billion barrels of proven Venezuelan reserves, and called it the biggest oil deal in world history.

Three days later the White House published the plan to build what it called “new robust, strategic and defensible supply chains in our hemisphere.”

On September 1, Venezuela’s National Assembly approved it. 

That same night, U.S. Energy Secretary Chris Wright landed in Caracas. And on September 2, the Venezuelan government signed deals to turn over the operation of 17 oil fields holding roughly 65 billion barrels of proven reserves to a private company. And that company granted the United States Department of Defense a 35% stake.

This deal puts the operation of a reserve base 40% larger than everything the United States has proven under its own soil into American hands, with the Pentagon holding a third of the operator.

Now, apply this model to Iran.

Kharg isn’t a target. It looks more like the last piece of the operation. Take the island, bring professional operators into the fields. Control the flow of oil and the flow of revenue, and the regime can’t fund itself back into existence.

And that shifts the global power dynamic of oil. For fifty years, the ability to withhold barrels has been the leverage used to wield global power. OPEC had it. Russia had it. Iran has been trying to use it in the Strait of Hormuz all year.

That oil will very likely (soon) be supplied on American terms.

We looked at this chart below back in July, when the 10-year Italian government bond yield was trading under 4%.  Today it traded 4.25%. 

As you can see it’s tracking (white) step-for-step with the rise in European natural gas prices (orange). That’s because sustained high energy prices feed inflation and higher interest-rate expectations across Europe. And for Europe’s heavily indebted governments (like Italy), higher rates ultimately become a fiscal problem.

This dynamic drives the doom loop for Europe that we’ve discussed over the past six months. Expensive energy drives European inflation. Inflation forces the ECB to hike. Hikes drive up the borrowing costs of Europe’s most indebted governments.

The natural gas price in Europe is a bond market problem.

With that, the ECB meets on the 10th. A rate hike is priced at a virtual certainty, with another by December. And ECB officials are publicly affirming it.

But a rate hike isn’t going to unlock energy supply for Europe that has been stalled, destroyed or regulated away. 

It’s only going to destroy demand in an economy that’s barely growing as it is.

Now compare the G20 in Asheville this week. Treasury Secretary Scott Bessent flew with Fed Chairman Kevin Warsh to North Carolina. And then he opened the Summit with prepared remarks alongside Warsh.

In an interview that morning, on bonds, Bessent said “of course we’re on the same page.” On rates, he said, “traditionally, you don’t raise into a supply shock.”

In my note yesterday, we revisited the path of the Trump 2.0 global economic and security campaign to its ultimate target: China.

As we discussed, the Trump administration’s moves of the past 19 months are about ending China’s multi-decade economic war on the West, which has resulted in economic power and political capture. 

How did they do it? 

They undercut the world on price. China used currency manipulation (a cheap yuan) to build an export monopoly. The world allowed it. They liked cheap stuff.

And they liked what China did with the dollars it collected from the cheap stuff. They plowed it into Treasuries, which supplied cheap credit for U.S. consumers to buy more cheap stuff.

And so the cycle has perpetuated through the years — transferring wealth from the U.S. (and the West) to China. 

That’s the trade imbalance that has broken the global economy, and has funded China’s influence building over the past decade.

With that, let’s talk about the G20 finance ministers meeting in Asheville that concluded today. 

It was like no other G20 meeting. 

The G20 is presided over by the U.S. this year. And from opening statements made with Scott Bessent and Kevin Warsh sitting side-by-side yesterday, it was clear that the decade-long global agenda designed around the low growth, high regulation, massive spending, demoralizing climate and social policy was over. 

This G20 was all about optimism, investment and economic growth.

With business and finance leaders from the world’s 20 largest economies at the table, the U.S. brought in the people leading the AI boom to explain the significance of this new industrial revolution.

They piped in Elon Musk for a discussion. He told the room full of people who have been conditioned to ‘secular stagnation’ that AI will increase the size of the global economy by 20%-30%! 

He said there will be a billion humanoid robots in the next ten years, and they will be 5 times more productive than humans.

By the end of the summit today, nineteen of the twenty members were on board with the Asheville communique.

One was not. China.

So, Bessent issued a “chair’s statement” instead of a communiqué. At the end of it, in small type, it said this: the statement was agreed by all G20 members present except China, which objected to paragraphs 4, 10, 11, and 13.

Four paragraphs. Let’s look at what’s in them.

Paragraph 4 is about energy.

It says the smooth functioning of key value chains, including energy, food, fertilizer and critical minerals, is essential to global growth. And it says free, safe and predictable navigation through the Strait of Hormuz is essential to sustaining that growth.

Remember, the clock is running on the economic isolation of Iran. And every country still buying, shipping, insuring or banking the Iranian trade on notice. That’s China. And China just dissented on the free and safe navigation through the Strait.

Paragraph 10 is about trade imbalances.

It says countries running excessive and persistent surpluses should remove the distortions that hold down their own domestic consumption and leave them overly reliant on exports for growth.

That’s China’s economic model. They dissented. 

Paragraph 11 asks the IMF to build better tools for measuring those imbalances, and to improve its data coverage of non-market policies and practices.

That’s the nineteen members calling on the IMF to do its job, and hold China accountable for unfairly manipulating its trade advantage (and therefore creating global trade imbalances). China dissented. 

Paragraph 13 is about sovereign debt.

It calls for broader coordination among G20 official creditors in restructuring the debts of countries that owe a meaningful share of their external debt to G20 members.

That’s Belt and Road. China is the largest bilateral lender to the developing world, and it has been the obstacle in nearly every sovereign restructuring of the past five years. China dissented. 

Now, let’s go back to February of last year, two weeks into this administration. I said China was priority number one, and that the trade war would likely require global participation — maybe putting China in the trade penalty box.

That was nineteen months ago. Today, at a G20 hosted by the United States, nineteen members put their names to a document about surplus countries and export dependence, and China sat alone on the other side of it.

The trade penalty box could be coming. 

Overnight, the kinetic action returned to the Strait of Hormuz.

Let’s revisit the path that got us here.

We’ll start with this excerpt from my February 2025 note, just a couple of weeks after Trump was sworn in: 

Dealing with China is priority number one … the Trump 2.0 trade war with China will likely require global participation (maybe putting China in the trade penalty box).  

It’s a multi-front fight. It’s fighting to rebalance global trade, and weaken the global reliance on China (weaken China’s economic and political leverage). 

As we discussed at the time, China was at the core of nearly every geopolitical move being made. Mexico and Canada were pressured over fentanyl, which comes from China.

Panama and Greenland were about shipping lanes, and keeping them out of China’s hands. On the day Rubio visited Panama, Panama announced it would exit China’s Belt and Road project.

Then tariffs. 

The tariffs were never about revenue. They were about realignment. Use access to the American consumer as the leverage, and draw the rest of the world back toward the United States (away from China). 

It worked. Country after country came back to the table.

Not China. China retaliated, built workarounds, and has stalled.

Then Venezuela, China’s “all-weather strategic partner.” 

This began the dismantling of energy as a geopolitical weapon — a funding source for global chaos, influence, and a tool for economic disruption.

In a cabinet meeting in May, Trump turned to Marco Rubio and asked what was going on in Venezuela. Rubio laid out the mechanism in public. 

He said, the industry is being “professionalized for the first time ever.”

The crude is sold “in the market at market rates.” And “the money is going to an account in the United States controlled and monitored by Treasury, audited by KPMG. And it’s for the first time ever, the money’s not being stolen. It’s going to the benefit of the Venezuelan people.”

That was the Venezuela model stated by the Secretary of State. A Treasury-controlled account. KPMG audit. Market sales. Revenue restructured away from the regime, toward the people.

Eradicate the regime. Take control of the oil. Remove the regime’s funding and leverage.

That was a clear signal for what was already underway in Iran.

And remember, on Iran, forty-years ago Trump told Barbara Walters that the next time Iran threatened this country, America should go in, grab one of their big oil installations, and keep it.

In 1988, he told The Guardian he’d do a number on Kharg Island, and take it.

This past March, he told the Financial Times that his favorite option is to take the oil in Iran.

And with that, there has never been a peace deal scenario that would change the control architecture of oil in Iran. The Venezuela model has been the model for Iran. Take the oil, professionalize the industry, sell it at market rates, and run the revenue through a Treasury-controlled account, so the old regime can’t reconstitute itself on that money.

Which brings us to the isolation strategy.

Last week, Scott Bessent (U.S. Treasury Secretary) started the clock on the economic isolation of Iran, and put every country still buying, shipping, insuring or banking the Iranian trade on notice.

He said, any entity that facilitates money laundering on behalf of Iran will be removed from the US dollar system.

Who does it put in the crosshairs? China.

China takes as much as 90% of Iran’s oil exports.

As we discussed last week, Venezuela was the model for Iran. And the economic isolation of Iran is now the model for China.

This, as Xi is due for a formal state visit, in America, on September 24th.