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US Inflation | Ellison & AI | BTP/Bund Spread

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“You are broken on the floor And you're crying, crying Still asking him for more ”

The whipsaw in the US interest rates markets continues, and they're still asking for more.

Big Tech, AI & Larry Ellison

The immense wealth creation in the Bay Area continues as Apple and Oracle announce partnerships with OpenAI, adding hundreds of billions to market caps. Larry Ellison can now buy the few remaining properties on the Redwood Shores, San Carlos, and Woodside (CA) Monopoly board he does not yet own. Whether directly or indirectly, Uncle Larry managed to tax us all by providing the world's most powerful and widely used database (Oracle) as an essential service.

For all the possessions and fancy toys Ellison has amassed over the years—and he sure loves to spend—he still shows up to the office at 8 am every day, hungry to win, even as he approaches 80. He's also different from your typical Bay Area entrepreneur who acts all self-righteous just because he or she is growing different varieties of meat substitutes for consumers. When not grinding away at work, he flies out on his private jet to his own island in Hawaii (Lanai) to cull some deer with the FBI SWAT squad. Deer overpopulation is a real problem.

Win by playing within the rules of the game

Ellison doesn't pretend to be a nice guy and prefers to shun the limelight. When he entered to compete in the Americas Cup, held in San Francisco in 2013, he secretly recruited the top 3 skippers in the world without letting it get out to the rest. Naturally, each skipper assumed they would lead the crew for Team USA, even though it was not explicitly stated in their contracts. Ellison fielded his best skipper and benched the two others who could no longer compete for another team. Let's face it… it would be kinda funny if the old man managed to pull a fast one on young (Sam) Altman.

Partnerships frenzy

Most AI tools and libraries are monetized through cloud services; Oracle and Microsoft are direct competitors in the space. So, we're probably missing the bigger picture behind these falliances. The Apple-OpenAI partnership seems a more natural fit, without as much overlap and conflicting interests with Microsoft's core business. The alternative could have been tie-ups with OpenAI's main competitors, such as Anthropic. Amazon has invested in the latter and plans to deploy its large language model (LLM) in the next generation of Alexa.

Previously, it was about taking money from investors, even if a startup did not need it, so that competitors would not get funded. Long-term strategic interest may take priority over immediate commercial rivalries.

Younger Ellison's failed Paramount bid

Unfortunately for Larry Ellison's son (David), it has not been such a great week for him. His bid to purchase Paramount Global with private equity backing fell through.

US Inflation | Ellison & AI | BTP/Bund Spread | Speevr
Photo by Chris Kleponis-Pool/Getty Images

It's only when pretending to be someone they're not that the press really go after them.

Fed Meeting Synopsis

Transitioning from the world where people are fast adding zeros to their net worth, to those eager to find out the exact timing of when the Federal Reserve will reduce interest rates from 5.5% to 5.25%. Let's at least pretend it matters a lot and that we care… listening to the pre-and-post FOMC announcement commentary on Bloomberg TV was unbearable. The official statement release and conference transcripts are useful.

A couple of brief observations to mention:

1) The reporters tried to tease out of Chair Jerome Powell whether the individual Fed forecasters' inflation projections (dot plots) were revised in reaction to the softer-than-expected CPI data earlier in the day. While the question is valid, the various interpretations are highly subjective due to flawed assumptions and logical inconsistencies. Powell continued to stress that the Fed committee considers economic data in its entirety and in the context of broader trends, and his response to the question reflected it.

In short, the Fed's economic projections published yesterday were unlikely to have been influenced by yesterday's inflation data. Nor is any committee member likely to blatantly admit to colleagues that they're chasing momentum by updating their forecasts.

2) The question the pundits and journalists were trying to get at was perhaps better addressed later in the conference when Powell said: “Today was a better inflation report than almost anyone expected”. If we presume ‘anyone' refers to the committee members, there are two opposing interpretations:

i) My own bias tilts to read it as a second consecutive month of softer inflation data is likely to allow the Fed to cut sooner than expected. A below-consensus producer inflation number today would help fortify the view.

ii) Craig's take is that the May CPI report is a statistical anomaly. Instead, it's better to focus on persistent trends in hotter housing and rent inflation data. He's probably right. You can read his current views, and those of others, here:

US Economy | Half-Time Score | Trade Signals

June 6, 2024

Revisiting baseline scenario and risks. Inputs from Goldman, Craig, Brazil, Slok & Krugman

Regardless of interpretations and personal views on the US economy, the decisions of the rate-setting policy committee ultimately matter for this discussion. After reading our comments, they are probably wondering what more they need to say or do to prevent monkeys with guns from injuring themselves.

There is less ambiguity around the state of the economy than for the path of monetary policy. The key people in making investment decisions are on top of the inflation story.

Rationale for BTP/Bund Spread Idea

There have been a couple of questions on the rationale behind the BTP/Bund spread call. Shortly after, Bloomberg published an article related to Italian debt sustainability and fractures within PM Giorgia Meloni's coalition. So here goes…

—The Bloomberg article (available to Terminal users) does not say anything especially new or insightful beyond what has been mentioned in the local Italian press.

—Our view has less to do with Italian domestic politics and Italy's debt sustainability, but more to do with potential turmoil at the EU commission.

—With Macron calling a snap parliamentary election in France, and the usual jostling in Brussels after EU elections, this has added to the uncertainty and widened the range of possible outcomes to include more unknowns.

We're opting for the BTP/Bund spread rather than OAT/Bund because the market for trading Italian debt is (structurally) more vulnerable to shocks. Namely, the stock of public debt as market securities is too high relative to the total capital in the local banking system. This makes liquidity provisioning and orderly transfer of risk difficult during periods of severe market stress. The US Treasury market experienced similar problems in March 2020, primarily due to regulatory constraints in the banking sector.

—Ordinarily, we are not fans of market bets grounded on unforeseen events unless there is reason to believe the risks are mispriced and the cost of being wrong is limited. Moreover, we're probably not the first geniuses to take a negative view on the Eurozone following the recent political turmoil in France. While buying the BTP/Bund spread currently offers less than even odds of a positive return, the payoff is highly asymmetric, and risks sufficiently elevated probabilities to make the trade compelling. There is an optimal point between probability and payoff as stories develop.

—We should also mention there are rumors that Mario Draghi is Macron's preferred candidate as the next leader of the EU Commission, ahead of Ursula von der Leyen to be re-elected.

—Shorting Italian sovereign debt is, and has always been, motivated by fears/jitters over low-probability events with high market impact. The moves are exacerbated by the disorderly functioning of markets due to structural issues already discussed.

It's also important to mention this is not an investment recommendation.

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US Inflation | Ellison & AI | BTP/Bund Spread

Tech bros vs. a real man. Rationale for BTP/Bund spread idea. FOMC takes