IMF, Banking Competition, AI Notes

IMF on Rates

The IMF released its latest World Economic Outlook last week, focusing on the messy state of global affairs and the impact that may have on interest rates. They expect interest rates to return to pre-pandemic levels based on the long-term trends that were present before Covid. Those trends include: slowing productivity, aging demographics, de-globalization and the increased debt required for the green energy transition.

I wouldn’t necessarily interpret this as a return to 0% interest rates. The policy set by the Fed is a short-term rate, while market participants price longer-term rates. Falling inflation should pave the way for falling interest rates, which will benefit asset prices as long as fundamentals don’t deteriorate too much. The current debate focuses on whether rates will settle below 1% or below 2% in the coming years. Regardless, both sides of that argument include rates significantly lower than where we are today.

You can track the purely mathematical impact of falling rates by following TLT, the 20-year treasury ETF. As rates shot up, this fund lost -45% from July 2020 to Oct 2022. Based on falling rates alone, a return to 1% or 2% rates would translate to a 20% to 30% gain in TLT from today’s levels. That’s not a recommendation. Falling rates positively similarly impact equities. If it takes two years for inflation and rates to fall, that gradual decline would translate to an attractive return for investors in most asset classes. On the other hand, the risk is the depth of a coming recession and the impact on earnings. If earnings fall dramatically lower, the drop in the discount rate matters less.

Apple Savings Account = more competition for banks

Apple released a high-yield savings account powered by Goldman Sachs with a 4.15% yield. Banks are in a tough position as bank deposits are the backbone of our credit system. Consumers will not leave their deposits in banks earning .01% when they can earn 4.15% at Apple or 4.5%+ in money market funds. Nearly all flows into investment accounts in Q1 2023 went to money market funds, 10x the amount that went into ETFs or mutual funds.

Personally, I’m not a fan of the fractional reserve banking system. Yes, it allows for access to cheaper credit and greater economic growth, but that comes at the cost of bank runs, bank failures and more bailouts. It’s a structurally unsound system that requires government support regardless of regulation.

Customers want custodial accounts where their assets are not used for any purpose. PayPal is a custodial account, for example. Brokerage accounts are also custodial, meaning assets like money market funds are held without loans tied to them. If Apple introduced a free custodial account with a checking and routing number, that would be another competitive blow to the banking system. Private credit and direct lending are also gaining market share as banks tighten their lending standards.

AI Notes

• AI Speed: Bessemer Venture Partners released their annual State of the Cloud report. They estimate the road to $1B in revenue for software will be approximately 50% faster than previous generations, thanks to AI. They also predict that the majority of the value produced by AI will flow to the end user. An example is how emergency room doctors have successfully leveraged ChatGPT to solve real patient cases with zero marginal cost.
• AI Competition: Amazon made CodeWhisperer free to developers without any usage restrictions. CodeWhisperer and tools like it dramatically augments software developer output and efficiency. This undercuts Microsoft’s $10/month Copilot.
• Fakes: An AI-generated song mimicking the vocals of Drake and The Weeknd was pulled from Spotify, for obvious reasons. A German artist won the Creative category in the most recent Sony World Photography Awards. He later revealed that the image was generated with AI and was not a photograph.