Douglass: Midterm Results Won't Slow Down AI Race, Inflation Outlook "Favorable"

[00:00:00] Speaker 1: Our next guest says the economic outlook is very good, but worries about the energy price shock. For more, we want to welcome in Stephen Douglas, Chief Economist at NISA Investment Advisors. Stephen, thank you so much for joining us this morning. Let's start with inflation. You say the underlying inflation trend is improving, but high energy prices have still been wreaking havoc on households. It's been a concern when it comes to diesel costs. We saw it play out in terms of the election. What's your take on what you're watching when it comes to inflation and the impact to households? [00:00:37] Stephen Douglas: Yeah, good morning, Diane. It's good to be here. As you said, we think the underlying inflation trend is favorable. Services have been in pretty steady disinflation for some time, especially on the housing side. And, you know, we've basically at this point weathered the tariff inflation shock, and now we are suffering through an energy inflation shock. We think that does present risks. You are seeing spillover effects through diesel, you know, that transports all the goods in the U.S. economy. And so that's been a troubling development just in the last couple of months, the September report in particular. But we do believe that once that goes away, if we can get energy prices down, then the underlying inflation trend will be revealed to be quite favorable and heading back towards the Fed's goal of price stability. [00:01:22] Speaker 1: That's a big if, because, you know, a big part of this obviously has to do with the war with Iran, and we thought this was going to end sooner than it has. I mean, you know, this is a conflict that we've been in now. It will be approaching a year quickly before we know it if things don't get resolved. Another thing that you mentioned that you are concerned about, stagflationary risk. Can you tell us a little bit more about your thought there? [00:01:48] Stephen Douglas: Yeah, you know, an energy price shock like this, you know, is a negative supply shock for the U.S. economy. So it does, you know, reduce growth and raise the price level relative to the alternative. Fortunately for the U.S. economy, this is nothing like the stagflation risks and stagflationary shocks that we saw in the 70s where the U.S. was heavily dependent on imported oil. These days, of course, the U.S. has energy abundance. We're net exporter of oil and energy products. And so it's really more the inflationary effects that we're worried about. It does slow growth, you know, at the margin. You know, consumer real incomes do get squeezed by higher gas prices. And that does, you know, present, you know, downside risk to the consumer. But, you know, as you've seen, the consumer has weathered every body blow here for the last few years. And so the main effect, you know, while technically it is stagflationary, the main impact that we're focused on is the inflationary effect. Obviously, Nyssa here, we're focused on the fixed income market in particular. And so it's the inflationary effect of energy and the transmission through monetary policy to shape of the yield curve. That's been our main focus and I think, you know, the main focus for the U.S. economy. [00:02:58] Speaker 1: When you think about the AI infrastructure build out, that was another thing that, you know, obviously came up at the polls. Data centers, not just based on individual platforms, but there were actual measures across the country about, you know, potential pauses to the build out, reframing, etc. Is the it's been a big tailwind for the economy. It's also led to some inflationary pressure. Is the reward greater than the risk or how do you how do you view the AI infrastructure build out as it relates to the economy? [00:03:33] Stephen Douglas: I'm very optimistic. I absolutely believe the reward is greater than the risk. I'll leave it to the technologists and others to talk about, you know, the doomsday scenarios and what the actual odds of those are. But, you know, as an economist, I can see that the infrastructure build out for for AI, for data centers and all the surrounding technology is driving U.S. growth right now. It is the hottest sector in the economy. It is the greatest source of upside growth. The consumer is still the largest share of the economy by far. But but clearly the AI infrastructure build out is is a is a big deal. It's also a major shift in in financial markets and capital flows in the U.S. economy. Again, these these these hyperscalers, these five companies were previously, you know, the most profitable companies basically in human history, generating 250 billion dollars of free cash flow every year. And they have now flipped to not only spending all of that free cash flow by borrowing, you know, 200, 250 billion dollars a year from from the capital market. So it's a big change, has lots of effects. The election yesterday, clearly, you know, a mood in the country and a shift was was revealed. But our view is, and again, we're going to be watching this very closely and it's obviously a fast moving environment. But our view right now is that any political constraints constraints that may be placed on that will be placed on on AI data center building, I think, is probably not going to be enough to completely derail the story. It might slow things at the margin. It might raise costs slightly at the margin in order for these firms to get, you know, these projects over the line and over the political opposition. But so far, it seems that they're you know, these companies have mostly been able to find other jurisdictions that are friendly when when one jurisdiction shuts down a data center. So we don't think it's it's it's necessarily going to derail the story, but it's clearly that's something that's moving fast and we're going to be watching it very closely in the months ahead. [00:05:29] Speaker 1: Stephen, I want to get a quick thought from you on the job market, because this is also a week where we've gotten some data. We've got private payrolls. We've got the monthly payrolls report coming from the government tomorrow. What's your take on the temperature of the job market right now? [00:05:44] Stephen Douglas: I think the labor market is is in is in great shape. It's a Goldilocks environment, not too hot, not too cold. You know, clearly the Fed's rate cuts last year were motivated by, you know, what, you know, sort of suddenly appearing a downside risk to the labor market. And we've been in this low higher low fire equilibrium for some time. And then last year, last summer, we had the big revisions, if you remember. And all of a sudden we got, you know, pretty seriously worried about, you know, that the labor market tipping over into a layoff cycle. So they delivered the three insurance cuts. Thankfully, the labor market recovered, stabilized and is now in a very good position. You know, we see we see healthy job creation again. You have to adjust for the rate of labor supply growth, which, of course, is lower today than it has been in the past, thanks to immigration policy and demographics. But we see we see job creation keeping up with that labor force growth, keeping the unemployment rate fairly steady in the quarters ahead. And thankfully, at least from the Fed's perspective, we're seeing wage disinflation continuing. No sign yet of any breakout to the upside in wage inflation. And so that's again, that's part of our our framework for for for assessing what we think is a fairly benign overall price inflation picture. [00:07:02] Speaker 1: All right. Thank you, Stephen. That's Stephen Douglas, chief economist and NISA investment advisors. Appreciate your take and assessment of the state of the economy.