US Equities Hit New Highs Amid Political Tensions and AI Hype

US equities reached new highs this week, but the market's reaction to political tensions and economic policies remains uncertain. The president's criticism of the Federal Reserve and calls for lower interest rates to reduce government debt have raised concerns about fiscal dominance, where a central bank keeps interest rates artificially low to accommodate government spending. However, the market seems unperturbed, with stocks continuing to rise and Treasury bonds remaining stable.

Fed Governor Christopher Waller suggested that with inflation near target and limited upside risks, the policy rate should be cut before the labor market deteriorates. This aligns with the market's preference for rate cuts, which could be a driving factor behind the current market sentiment. However, the market's reaction to political tensions and economic policies remains uncertain, with some analysts suggesting that the market may have conceded that policy doesn't matter as much as previously thought.

Meanwhile, the potential impact of artificial intelligence on the economy is becoming increasingly apparent. Mark Zuckerberg, CEO of Meta, stated that the company is seeing early glimpses of self-improvement with AI models and that superintelligence could be just two or three years away. This raises questions about the relevance of current economic policies and monetary decisions in the face of such rapid technological advancement. If AI surpasses human intelligence in all fields, the economic landscape could change dramatically, potentially rendering current concerns about fiscal dominance and monetary policy obsolete.

The potential impact of AI on the economy is not limited to the US. China has made significant strides in scientific research, potentially pulling ahead of the US in the race to superintelligence. This raises concerns about the US government's decision to cut research grants, which could hinder the country's ability to compete in this critical area. However, US mega tech companies like Amazon and Microsoft are reportedly reducing their payrolls by thousands of employees, believing that AI can take over more of the work. This could lead to increased profitability for these companies, further cementing their position as global leaders in technology and innovation.

Despite the potential impact of AI on the economy, the market for forward inflation expectations implies that US inflation will be just 2.3% in five years' time. This suggests that the market still has faith in the Fed's ability to manage inflation and maintain economic stability. However, the rising risk of fiscal dominance and the potential impact of AI on the economy could still pose significant challenges for the US economy in the years to come. It remains to be seen how the market will react to these challenges and whether the current market sentiment will continue to hold.