Monthly Macro: Higher for Longer? Inflation, Interest Rates, and the AI Investment Cycle

Chris

Hi everybody. Today is Friday, September 25th, 2026. Welcome back to another episode of Monthly Macro. There's been one dominant debate in markets over the past several weeks around the recent rise in bond yields and whether it's a temporary adjustment or if we are entering a fundamentally different economic regime where inflation, interest rates, and nominal growth sell at higher levels than investor investors are accustomed to.

And then, at the same time, enthusiasm around artificial intelligence continues to build. Many investors believe AI driven productivity gains will eventually bring inflation lower and support stronger economic growth. But the reality may be more nuanced.

So, joining me to discuss is William Blair macro analyst Richard de Chazal. Richard, great to have you back.

01:08, Richard

Great to be back, Chris.

01:09, Chris

Starting with the big picture. You've written repeatedly that investors may still be viewing the economy through the lens of the 2000 to 2020 period. The last two decades. Why do you believe we're entering a different regime for inflation and interest rates?

01:24, Richard

I mean, we're already in this new regime, and I think, you know, we have been since 2020. And I think what a lot of investors think is that what we're facing is really just a series of sort of one-off shocks, one-off supply shocks, and those are going to kind of dissipate. And once we get over this, sort of, “little hill” of higher energy prices from the closure of the Strait of Hormuz, we'll be back down to sort of that old normal of kind of below 2%, that sort of old-regime world. And, you know, it's job done.

And I don't think it's that easy. I think, you know, this is a new regime we're sort of stuck in, which is not dramatically higher, but it's sort of 2.5% to 3%. And we're not going back to that old one in a hurry. And I think most of the disinflationary forces that lowered inflation during that 2000 to 2020 old-regime block have now either disappeared, they're not really exerting as much pressure, or some of them are actually doing the reverse and raising pressure.

And I think it's worth remembering that, you know, back then we were talking a lot about the global savings glut. It was Paul Krugman and Larry Summers's secular stagnation. Remember, we had soft demand. And on top of that, we had, on the supply side, these sort of positive shocks from globalization, good demographics, tons of immigrants, no trade unions. We had abundant energy. Central bankers were gods. And, you know, even to the point in the early 2000s, late 1990s, remember, we actually had a budget surplus.

You know, that's when Greenspan was legitimately, you know, in Congress talking about what would happen if the debt gets too small. So that's pretty far from where we are today. I think that was the golden era.

And I think what we're facing today is more like we're seeing a structurally tight labor market because of immigration and demographics. I think governments have really rediscovered that power of the purse and the printing press, and they're using that. We have trade wars, cold wars, hot wars, all taking place at the same time. Those are gumming up supply chains. We have shortages of energy, you know, just looking at today's level of demand, let alone what this sort of AI future is going to demand. We have a whole reindustrialization going. We have more defense spending.

And on top of that, you know, we're just starting to see this latest bout of climate-related change with this super El Niño, which is unraveling. You know, I saw in the paper the other day that the Panama Canal is now reducing the amount of ships that can pass through because there's not enough water for them to go through.

So, again, I think, for me, this is more than just a series of temporary one-off shocks. And I think it's the new normal.

05:07, Chris

All right. So, let's turn to bond markets. One of your recent themes is that the path of least resistance for yields may remain higher. What's driving that view? And how important is the role of a higher R*? And maybe, for the general audience, explain what an R* is again.

05:24, Richard

Okay. So, yeah. So I wrote a note back in early August. That was when ten-year yields were about sort of 4.6%, something like that. And then, since then, they've basically been on a tear. So now I think they'd been at 5.17%. So that's a pretty big jump in a very short space of time. And I don't think it's unjustified.

Like, again, I don't think this is something that's gonna… those yields are going to shoot back down very quickly. So why is this happening?

I think part of it is related to inflation. We've just been discussing maybe the realization that we are, kind of, in this sticky inflation world. If you look at, actually, if you sort of decompose the yield, the inflation component, so those inflationary expectations from TIPS yields, which you can kind of subtract out, those actually haven't moved up all that much. So maybe it's, you know, the market's saying it's less of a factor in this increase.

Certainly the Fed has obviously been raising, or has raised, interest rates once and is expected to raise a few more times. And obviously, if long rates are the sum of expected future short rates, that should push up long-end yields.

I think debt is part of the story, even though, you know, quite a few people are saying that's not really the case. I think, you know, all this talk about $40 trillion debt now, pressure from Secretary Bessent on the bond market, and sort of rejigging the distribution or issuance of bonds, I think that's a factor.

And actually, if you look at global bond markets, yields have been increasing across the globe, certainly for developed market economies, particularly in France, Germany, and the U.K.

And I think what's interesting, too, is that if you rank countries by the size of their debt and then put that against the change in bond yields, I think what we see is those countries with the largest debt-to-GDP are actually the ones that have seen the largest selloff in their bond market.

So I think debt has been a factor. But I think the biggest factor is a positive one, and that's been stronger economic growth. So, kind of the opposite of secular stagnation. And I think that's great. You know, where do we, or how can we gauge what's, sort of, the right level for growth? And I think a good, sort of, guidepost is just simply looking at nominal GDP growth.

And I think what we saw in the second quarter was nominal GDP rose 8%. I think something, again, like that is expected in the third quarter. So that's obviously really strong. And I think what's important is, again, nominal GDP acts like an anchor or a tractor beam for those ten-year yields. And that's, I think, for two reasons.

One is, if you just look at the breakdown of nominal GDP, what is it? It's real economic growth, so real output growth plus inflation. And if you look at what a bond yield is, a bond yield is real growth plus expected inflation and a term premium. So obviously very similar components there. And because of that, I think you shouldn't get dissimilar rate and levels of growth there.

So that's one thing. I think the other thing is simply because if you have an economy that's growing, you know, 6% to 8%, that probably also means that revenue growth is a lot stronger for the corporate sector. So, equity returns, or returns for other assets, are also going to be quite high. And I think that naturally increases the competition for capital.

So, you know, bonds, if they're offering yields of, I don't know, 2% to 3%, that's, you know, clearly not very attractive compared to, you know, your risk-adjusted return on what you're getting on equity. So those yields naturally are going to have to go up to attract the capital that's needed. And that's fine. That's healthy.

I think for your R* part, I mean, so R* is the real neutral or equilibrium interest rate. So the rate that's kind of required for the economy, so it balances growth and inflation. So inflation is not accelerating. It's at that sort of 2% target, and growth is fine.

So, it's an estimated rate. So, it's unobserved. We don't really know what that rate is, and we, kind of, estimate what it is. If interest rates are above it, they're sort of deemed restrictive. If they're below it, they're deemed accommodative, or policy is accommodative.

And I think what really drives it is faster productivity growth or changes in productivity growth. And I think what we've seen is we have seen productivity growth accelerating. And I think as a result of that, we've seen that R* rate, or the nominal R* rate, is being revised upwards.

So, the Fed, in its last FOMC meeting just, you know, a week or so ago, increased its estimated nominal R* rate to 3.2%. It had been as low as 2.8% back in 2022.

And if you look at sort of what the market is estimating for R*, which you can do by looking at the five-year, five-year forward OIS swap rates. Not to get too technical, but it's basically an expected Fed funds rate for a five-year period starting five years from now, right? So beyond near-term cyclical expectations.

And the market currently has that at 4.7%. So that's the highest since 2011. So the market clearly sees faster growth. And again, if long rates are expected future short rates, and you have a nominal neutral short rate of 4.7%, an equilibrium level for your ten-year yield of 5% to maybe 5.25% doesn't look all that abnormal to me, right?

So, you know, could we overshoot on the upside? Clearly that's a risk right now that markets are worried about. There's already people talking about ten-year yields going to 6%, which I think, if that were to happen, would clearly put a lot more pressure on the equity market than we're seeing so far.

I think right now markets are kind of taking it in their stride, really, because it's growth-driven. This is not an inflation scare or for some other reason.

13:01, Chris

All right. So, a common pushback to the higher-for-longer narrative is AI.

Many investors believe AI-driven productivity gains will eventually solve the inflation problem. Why do you think that argument may be too simplistic?

13:17, Richard

Yeah. It's not that I'm skeptical AI will boost productivity. I definitely think it will. It is, and it will continue to. But I think, you know, in the short run, what's happening is it's actually more inflationary than disinflationary or deflationary because you're still building out all this infrastructure. So that means that demand growth is growing faster than the available capacity.

So that's one thing. I think over the longer term, the thing is, sure, AI is going to be productivity-enhancing. But what I question is whether it's going to be enough to offset all of that other stuff we just talked about, right? So, is it going to be enough to offset, you know, budget deficits and demographics?

Remember, you know, a lot of people say, well, what about what happened in the late 1990s? And Greenspan was so prescient in predicting productivity growth was going to be so disinflationary and convinced the Fed not to raise rates. But I think, again, what was happening there was, yeah, productivity was positive. But you also had all those other disinflationary tailwinds at your back, like those budget deficits, which were rapidly moving into surplus. So, productivity, then, was a tailwind amongst a bunch of other tailwinds.

Whereas today, I think it's a very strong tailwind, but it's also coming up against a bunch of other headwinds. So I think it's going to be helpful. I think it's going to help to keep, you know, any other inflationary headwinds at bay. But I think it still could be consistent with, say, a 2.5% to 3% inflation regime we're seeing.

15:19, Chris

So, staying on AI. Let's talk about the investment cycle itself. You know, where do you think we are today? And then what are the biggest risks investors should be monitoring?

15:28, Richard

So, we're definitely in a CapEx cycle, right? This is not a consumer-driven expansion that we're in. This is definitely a CapEx expansion. And within that CapEx expansion, I think what we're seeing is, kind of, maybe, two cycles going on.

The first is obviously the AI-driven one. So that's data centers, production of fabs and semiconductors, and, in particular, the increase in energy and all the power that's needed to power that.

And I think the second one is, kind of, maybe we'll call it the old-school industrial cycle. And, you know, I think that's just companies that are upgrading their capital stock, which is actually really old. You know, they haven't updated it for years because they were choosing labor over capital when we had a real abundance of labor.

And I think, you know, the government is also incentivizing them to upgrade that capital through tax incentives, the One Big Beautiful Bill, all that kind of thing. And I think they're also sort of being pulled forward on the tail of AI and innovation, where we're starting to see maybe some FOMO that their competitors are investing more in CapEx and they need to as well.

But where I think we are in the AI part of this, maybe the fourth or fifth inning. And why is that? I think because we can see that demand is still far outpacing capacity.

So even though prices are falling because we're getting more efficiency there, we are starting to see more competition coming through, which suggests, you know, we're a little bit outside of those early stages of the cycle.

So, you know, if you look at a classic sort of stylized CapEx cycle, you see demand for a product very strong, and more supply comes on. Then you start to get more competitors coming in, and you start to see profit margins being eroded.

And I think what we're seeing now is demand is still very strong. Capacity is building. We're getting more competition coming in, say through China, their open models. But profit margins are still extremely strong. And maybe we're at peak margins. But I think also, if you look at when margins typically peak in the economic cycle, it's usually about mid-cycle, right? So, it's definitely not the end of the cycle.

So, to me, it sort of seems consistent with being fourth or fifth inning on the AI stuff. If you think about that sort of old-school CapEx cycle, I think we're probably still in the early part of the cycle there, and there's a lot of catching up to do.

So, companies have been slow and cautious to invest. They'd be worried about tariffs and immigration restrictions and that kind of thing.

And in terms of the risks, I would say, you know, if you look back at history, these types of cycles, how they typically end is you get overexpansion. You get too much capacity built, and that overpowers the available demand, or demand is satiated. Demand starts to slow down for various reasons.

You know, Jeremy Grantham likes to always compare it to the railroads where, back in the mid-1800s, you were basically building out eight different lines of railroads to take you from Manchester to Liverpool, which, you know, maybe only one or two were actually needed.

And, you know, I don't think we're anywhere near that yet with regard to data centers, or the supply of more powerful chips, or power itself. But, you know, that would be something to watch out for. So, you know, overexpansion.

Higher rates are clearly a risk. So, I think what you typically would worry about is expectations of future growth get really elevated. Companies start to take out a lot of debt on the back of that. The economy heats up. Rates start to rise to cool inflation or get compensation for any higher inflation. And then, you know, that starts to cause trouble.

And again, you know, we are starting to see more debt being taken out, certainly by the hyperscalers. I think, for the moment, they have the balance sheets, very strong balance sheets, to be able to do that. But, you know, it's a sign we're a little bit further on in the cycle.

Again, it's not the early stage of the cycle when all of that expansion was funded internally through free cash flow. So again, something to consider there.

And I guess the last thing is sort of, historically, you know, you don't really see it at the time, but historically, you do see lots of silliness taking place. You know, off-balance-sheet activity, or returns being covered up by accounting shenanigans, or that kind of thing.

And, you know, those are harder to see, and it doesn't seem like we're seeing a lot of that at the moment. But, you know, what I would say is that I don't think this CapEx cycle is going to be dramatically different from any that have happened in the past.

You know, we're probably going to have overbuilding. There are going to be winners and losers. It's just that we're probably several years away from that now. But, you know, I think investors should still be cautious, and some healthy skepticism is always a good thing.

21:49, Chris

Let’s finish with the Fed.

Following recent policy decisions and commentary, what message do you think policymakers are sending investors, and what does it mean for markets heading into year-end?

22:00, Richard

I think the Fed, at the last FOMC meeting, raised rates 25 basis points. I think the signal was that they're going to continue to raise rates. I think that was a good move. I think it helped the Fed's credibility. If they hadn't raised rates, I think that would have been very damaging for the Fed's credibility and would have promoted further talk of Chair Warsh being Trump's sock puppet.

So, I think that helped to squash that. And I think Chair Warsh has been consistently quite hawkish in what he's been saying. So, I think that's good.

I think what we're in is a mini tightening cycle, if you will. So, if you look back at past Fed tightening cycles, the Fed has, on average, since sort of the mid-1980s, during a tightening cycle, increased by about 300 basis points.

I don't think we're going to have 300 basis points in tightening today. I think maybe three rate increases. So, we just had one, maybe two more. So, a total of 75 basis points, which would be a very short tightening cycle. I don't think inflation is dramatically overheating. You know, I just think it's some supply-side things, which, it's true, the Fed has more difficulty tackling.

And the Fed's job here is really not to crush growth. It's to dampen down the potential for greater second-round inflationary impact. So, for example, keeping inflationary expectations from starting to rise, keeping demands for higher wages and salaries being sort of more muted. So really to try and prevent inflation from accelerating further, right?

So, the Fed can't print more oil. It can't print semiconductor chips, all of that stuff, for sure. But it still can help to prevent those second-round effects from kicking in.

So, I think that's what they're trying to do.

24:24, Chris

Maybe one more thing to close it out. If you could just, you know, if there's one message investors should take away from today's discussion, what would you say it should be?

24:31, Richard

Again, I mean I've been harping on, I think it's we should be cognizant that we're in this new sort of 2.5% to 3% inflation world.

And I don't think a ten-year bond yield of, you know, five, five 25 as kind of the new equilibrium rate. You know, that feels about right to me.

So I think we should, we should, kind of, get used to those sorts of levels.

24:59, Chris

Well Richard thanks for the insight, as always. Thanks to everybody for listening. We'll be back next month with another episode of Monthly Macro. Take care.