Why AI and Robotics Will Prove Every Economic Pessimist Wrong!

KR Opinion

Over the past several days, I have intensely focused on the bond market and the complex dynamics unfolding in the wake of recent developments. The ten-year Treasury has experienced significant volatility since Moody's announced its downgrade. While there has been considerable discussion within the financial community about the implications of this rating reduction, I believe this downgrade was actually overdue by about three years. The markets had largely dismissed this development until today's events provided a stark reminder of the underlying tensions.

The catalyst for today's market disruption was a twenty-year bond auction, albeit a relatively modest one at sixteen billion dollars. However, what caught everyone's attention was not necessarily the size of the auction, but rather the dramatic spike in rates that followed. Many market participants are pointing to this as evidence of a potentially troubling situation developing in the Treasury market. While there may be some validity to these concerns, it is important to understand the context of what we're dealing with regarding twenty-year bonds.

The twenty-year Treasury has always been somewhat of an awkward maturity in the bond market ecosystem. It doesn't fit neatly into the standard duration preferences of most institutional investors, who typically gravitate toward the more liquid two, five, ten, and thirty-year maturities. This so-called bastard maturity, as it's sometimes referred to in trading circles, rarely receives the enthusiastic reception that other Treasury offerings enjoy, simply because it doesn't align well with the asset-liability matching requirements of most institutional portfolios.

The real test of market sentiment and Treasury demand will come with future ten-year auctions, which represent the heart of the Treasury market and serve as the benchmark for countless other financial instruments. During today's turbulence, we witnessed the twenty-year Treasury reach a new eighteen-month high in yield, which is certainly noteworthy from a technical analysis standpoint. This development suggests we may be observing the formation of what bond traders refer to as a humpback yield curve, though it remains to be seen whether this configuration will persist or if yields will normalize in the coming days.

Much of the current market anxiety can be traced back to the Congressional Budget Office's assessment of the proposed tax cuts and their projected fiscal implications. However, anyone with experience in bond trading knows that the CBO's track record for accuracy is roughly equivalent to that of your average economist, which means it has been consistently unreliable. When we examine their previous forecasts, particularly regarding the last round of tax cuts, we find that they were off by more than a trillion dollars in their projections. Contrary to their predictions of reduced tax receipts, revenues actually increased during that period.

This pattern of inaccuracy highlights a concerning trend I've observed in today's markets, which I discussed in detail in a recent analysis. We appear to be dealing with a new generation of market participants who, while not lacking in intelligence or dedication, seem to have a different level of foundational understanding about certain market segments, particularly the bond market. The Treasury market is not just large; it's enormous, with an influence that extends far beyond domestic borders to shape global financial conditions.

While today's twenty-year auction was poorly received by market standards, we must resist the temptation to extrapolate this single event into a broader trend affecting all Treasury auctions. I have warned for years that we are always just one poorly received bond auction away from significant market disruption, but this warning has traditionally applied to the primary maturities that form the backbone of the Treasury market, not to the less liquid twenty-year bonds that few institutions actively seek to hold.

The CBO's estimates, in my opinion, deserve considerable skepticism given their historical performance. However, markets are currently treating these projections as absolute truth, and we must recognize this reality even while questioning the underlying assumptions. Today's events triggered an eleven-point two basis point increase in ten-year Treasury yields, which was enough to cause equity markets to tumble as the interconnected nature of financial markets asserted itself.

As we approach Thursday's trading session, we're observing some stabilization in equity markets, but the ultimate direction will largely depend on how Treasury securities perform. The correlation between bond yields and stock prices has become increasingly evident, and market participants will be watching closely for any signs that today's weakness in Treasuries indicates the start of a more sustained trend rather than being an isolated event.

The upcoming labor market data, including the weekly initial jobless claims and continuing claims figures, will provide further context for market movements. These reports have been relatively predictable in recent weeks, and I don't expect any major surprises that would significantly alter the current market narrative. The focus will remain firmly on the Treasury market and whether the weakness we observed today signifies a temporary disruption or the onset of something more significant.

I've been closely monitoring the Treasury market over the past several days, and I intend to keep this intensive focus due to the potential implications for broader financial markets. The key level I'm observing is seven and two-tenths percent on the ten-year Treasury yield. This represents what I deem a critical threshold, a drop-dead rate that, if surpassed, could lead to a move into the five percent handle and potentially much higher yields. Such a development would have significant implications across all asset classes and could indicate the beginning of a more challenging period for financial markets.

There seems to be additional risk factored into the markets currently, exceeding what fundamental economic conditions might warrant. This indicates that market participants are becoming increasingly worried about factors that go beyond the immediate economic data. The interaction between Treasury yields and the US dollar will be especially crucial to watch in the upcoming days, as these two markets typically move together and offer insights into global investor sentiment regarding American economic prospects.

The Treasury market will remain in a high alert status, a designation I've maintained for several days now as these dynamics have unfolded. The fundamental issue with the CBO's projections lies not only in their historical inaccuracy but also in their methodology and underlying assumptions about future economic growth. Their current estimates reflect a pessimistic view that appears to ignore the transformative potential of technological innovation and productivity improvements.

The CBO's argument revolves around the idea that US economic growth will slow down over the next three decades due to demographic challenges, such as declining birth rates and an aging population. While demographic trends are indeed significant factors in long-term economic modeling, this analysis seems to overlook the counteracting forces that are simultaneously at work in the American economy. We are witnessing unprecedented innovation in robotics, artificial intelligence, and entirely new business models that are creating novel pathways to capital formation and economic growth.

The demographic argument, while valid in certain contexts, fails to account for the productivity gains that technological advancement can generate. If my expectations for productivity improvements prove correct, we could see GDP growth exceed three percent, which would fundamentally alter the fiscal trajectory that the CBO is projecting. This represents more than just an optimistic view; it reflects a belief that the only sustainable path forward involves growing our way out of current fiscal challenges rather than accepting a managed decline.

The CBO's methodological issues are well-documented, and their acknowledgment of needing to reform their forecasting approaches essentially admits that their current models are not effective. The longer the time horizon of their estimates, the less reliable they tend to become, which is particularly problematic when making thirty-year economic projections that will inevitably be influenced by technological developments we can barely imagine today.

The current market environment reflects an overwhelmingly pessimistic view of future economic prospects, especially given the significant capital investments flowing into artificial intelligence, robotics, and related technologies. These investments are not merely speculative bets on upcoming technology; they signal fundamental shifts in how businesses will operate and value will be generated in the coming decades. The transformation happening in American industry through these technological advances indicates that traditional economic models may fall short in capturing the full scope of potential growth and productivity improvements that lie ahead.

Economic Releases

May 22

• 08:30 ET: Initial Claims For: 05/17 | Trading Impact: High | KR Forecast: 230K | KR Cons: 232K | Prior: 229K

• 08:30 ET: Continuing Claims For: 05/17 | Trading Impact: High | KR Forecast: NA | KR Cons: NA | Prior: 1881K

• 09:45 ET: S&P Global US Manufacturing PMI - Prelim For: May | Trading Impact: Medium | KR Forecast: NA | KR Cons: NA | Prior: 50.2

• 09:45 ET: S&P Global US Services PMI - Prelim For: May | Trading Impact: Medium | KR Forecast: NA | KR Cons: NA | Prior: 50.8

• 10:00 ET: Existing Home Sales For: Apr | Trading Impact: High | KR Forecast: 4.10M | KR Cons: 4.15M | Prior: 4.02M

• 10:30 ET: EIA Natural Gas Inventories For: 05/17 | Trading Impact: Low | KR Forecast: NA | KR Cons: NA | Prior: +110 bcf

May 23

• 10:00 ET: New Home Sales For: Apr | Trading Impact: High | KR Forecast: 690K | KR Cons: 679K | Prior: 724K