How bad could it get? That is the question on the minds of many investors as the war in the Middle East slogs on with no apparent clarity about, well, anything. Let’s do a quick check-in to see where we are as of this somewhat rainy Friday morning in the Washington, DC environs where we ply our trade.

When In Doubt, Equivocate

The S&P 500 stock index has lost around 7.2 percent of its value from its last record high, on January 27, to its close on Thursday. That is considerable, but the index has yet to cross either of Wall Street’s technical drawdown lines – a correction, which happens when the peak-trough reversal hits 10 percent, or a bear market, when the damage reaches 20 percent.

The relatively measured pace of this drawdown suggests that a multitude of scenarios are at play, with rosier projections imagining a near-term cessation of hostilities and eventual resumption of something approximating normal energy flows from the region to export markets, and less optimistic takes assuming that the absence of an obvious exit ramp today raises the probability of a structural quagmire. What this implies is that, within the current picture of a mid-high single digit percentage decline in stock prices, you have assumptions ranging from $200 oil  to $60 oil by the time summer rolls around, with all the attendant secondary and tertiary effects in the broader economy.

About that Broader Economy

Let’s step back for a minute from the war and think about that broader economy as it exists today. We have finished tabulating corporate sales and earnings results from the fourth quarter of last year, and it was in fact a pretty good quarter. S&P 500 earnings per share grew 13.4 percent over the quarter, a much better result than the 7.1 percent consensus projection economists were making as the fourth quarter got underway. Earnings season for the first quarter of this year will kick off in a couple weeks, and here too the outlook is fairly cheery, with the EPS growth consensus currently priced in at 13.0 percent – again, this is a higher projection than earlier estimates. In other words, even with the near-certain prospect of higher inflation looming – the Organization for Economic Cooperation and Development came out this week with an estimate of US inflation rising to 4.2 percent – the consensus among economists who follow these things is that companies will continue to enjoy double-digit profits growth.

Of course, just as the price trend in the S&P 500 reflects those myriad prognostications by the Pollyannas and the Cassandras of the market forecasting world, so to do assumptions about the health of corporate earnings depend in no small part on how things fare in the Gulf. Here is one example: helium. You may have had no personal exposure to this element other than shoving a handful of helium-filled balloons into your car on the day of your three year old daughter’s birthday party. But helium is a critical input for the advanced memory and training chips employed by artificial intelligence models. The vast majority of these chips are manufactured in either South Korea or Taiwan. A large portion of the helium they need for the manufacturing process comes from – you guessed it – the Gulf region and has to pass through – you guessed it again — the Strait of Hormuz. Inventories are running low, and there have been some rumors circulating this week that Taiwan’s helium supplies were down to just a couple weeks or so.

Given that spending on AI infrastructure was plausibly the largest single driver of US growth in 2025, it obviously should be of no small concern to contemplate the possibility of significant ruptures in the supply chain that feeds AI spend (it also serves as a useful reminder that, for all the talk of a rapidly deglobalizing world, these supply chains are still very much interconnected across multiple regions and nations). This is just one example of what we mean by secondary or tertiary economic effects. A full suite of scenarios is currently at play. With time, though, the practical range of outcomes is going to winnow down, either to the upside or the downside. The decision makers responsible for whatever happens next do not have unlimited time on their side.

This is not stagflation! Or so Jay Powell insisted, during the Wednesday press conference this week following the Federal Open Market Committee meeting that, as widely expected, kept US policy rates on hold at present levels. Stagflation was a thing we had to deal with, very harshly, in 1979, when turmoil in Iran was just one of many factors fanning the flames of consumer inflation. Paul Volcker’s Fed had to raise the Fed funds rate, ultimately to as high as 20 percent, to corral inflation and reinvigorate the economy’s potential to grow. Anything less than the experience of 1979-80, in the world according to Jay Powell, does not merit the term “stagflation.”

Wrong Direction

We’re not in 1979, that much is true. But we do have the two components of that word – the “stag” and the “flation,” if you will, both moving in the wrong direction. On Wednesday we got a report showing wholesale prices in February moving considerably higher than economists had been expecting – and that report reflected activity before hostilities in the Middle East broke out at the end of last month. Inflation is moving higher while the jobs market is weakening (and Powell and his Fed colleagues believe that actual conditions in the labor market are worse than the already-bad numbers in the jobs reports).

So how is all this affecting conditions in the bond market? The chart below shows the one-year trend for Treasury yields at the two and thirty year maturities, along with oil prices, noting the before-and-after conditions around the Middle East war.

Since the attacks began on February 28, the 2-year Treasury yield (the blue line on the chart) has jumped from around 3.4 to 3.8 percent, a percentage move of around 12 percent. The 30-year yield (green line on the chart) has moved from around 4.63 to as much as 4.91 at the same time, a more modest but still solid percentage gain of about 5.8 percent. Remember that bond yields move inversely to prices, i.e. higher yields mean falling prices. At first glance this might seem counterintuitive. In a risk-off market environment, like the present, Treasuries are supposed to be the refuge, the safe haven where capital flows in search of security. The problem, of course, is that this is a risk-off environment in which at least several among all the possible outcomes have inflation settling in for a more structurally elevated duration, thus making present nominal yields look relatively unattractive.

Strains on the Upside

The problem with writing these commentaries in the middle of a very fluid and rapidly changing environment is that events can move faster than the hand can type (yes, we do our pieces the old-fashioned way, without the divine intervention of ChatGPT). As of mid-morning Friday, yields at both the short and long ends of the curve are pushing higher without much apparent hedging sentiment to pull them back. The 30-year is at 4.94 as this sentence is being typed, already some six or seven basis points up from where it started the day. Although, as the above chart will show, the 30-year yield has been well above this level on a handful of occasions in the past year, so we would still characterize the market as bent but not broken, with at least some safe haven muscle memory to offset the inflationary push.

The short end of the curve is relatively easy to explain: taking their cues from the Fed and from what they see around them, bond investors are backing off from the previous assumption of one or more rate cuts this year (even though the median expectation from the Fed itself, in the Summary Economic Projections released on Wednesday, still calls for one rate cut in 2026). Market yields are adjusting accordingly.

At the long end, where rates are influenced by a wider variety of variables than just monetary policy decisions, the capitulation could start in earnest if the 30-year moves significantly north of five percent. That would, in our opinion, be a high-probability outcome if the consensus around the war converges on the assumption of no end in sight for the disruption to energy markets. This week’s bombing of critical energy infrastructure sites in the region has pushed sentiment towards that position. It’s still far short of a universal consensus, but it is also making the best-case scenario of a quick and relatively painless end much less likely.

On Wednesday this week the Bureau of Labor Statistics released the Consumer Price Index report for February. Economists had been expecting to see a year-on-year increase of around 2.4 percent in the headline inflation number, with an attendant gain of 2.5 percent in core CPI, excluding the volatile categories of energy and food. That is more or less what happened. But it happened last month; in other words, before a series of air strikes by the US and Israel had the effect of shutting down the passage of shipping traffic through the Strait of Hormuz.

As a refresher from last week’s commentary: approximately 20 percent of the world’s oil exports pass through the Strait of Hormuz, a sea lane with a span of roughly 35 miles bounded on three sides by Iran and one side by Oman. How much longer will this critical bottleneck remain shut? Given the volatile state of play in this unfolding crisis, who knows? Maybe tensions will be resolved by the time you are reading this piece on Friday afternoon. Maybe it will be out of service for weeks or even months to come. In a column this week on Substack the economist Paul Krugman noted that the “hit to oil prices will if anything be bigger than earlier crises” (Krugman’s own words) if the Strait were to remain closed on an ongoing basis. With that in mind, it is worth spending some time looking at what those previous crises meant in terms of inflation – both the core number which is the main object of focus for the Fed, and the headline number which actually takes into account the money you and I spend every week on groceries and gas. Forget that February CPI report, and prepare for something different in March and April.

Not Just a Headline Story

In the chart below, we show the trend for both headline and core CPI since January 1970.

We focus on four key events over this span of 56 years: the Yom Kippur War of 1973 that led to the first round of OPEC oil price shocks, then the Iranian Revolution at the end of the 1970s that sent prices soaring again, then the Chinese supercycle of explosive growth in the first decade of the twenty-first century, and finally the inflationary spike that came on the heels of the Covid pandemic.

In the two oil shock-related events of the 1970s we see an instructive message about the relationship between headline and core inflation. Again – this distinction is important because the Fed focuses most closely on core inflation for its monetary policy deliberations, due to its purportedly lower volatility. Most of the time that is a valid assumption. But consider the trend during those two bursts of inflation in 1973 and 1979. Headline inflation (the green line) started surging first, but core inflation (blue line) was fast on its heels. If an oil price spike is short-term in nature, then its knock-on effect into other goods and services will be relatively mild. But if it is structural – and the OPEC and Iranian events were both structural – then the inflationary effects will be far more pronounced across far more economic sectors.

We can contrast what happened in the 1970s with the China supercycle of the 2000s. You can see here that headline inflation went up by a lot while core inflation was actually pretty stable. Remember $5 dollar gas in 2005? That was the supercycle. In fact, the inflation-adjusted price of a barrel of crude oil in this period was higher than it was in either of those 1970s-era crises. But the main cause of high oil prices in the 2000s was China’s voracious demand for any and all forms of energy inputs. Those inputs powered the manufacturing plants churning out loads of goods that made their way back to the US and other developed economies as consumer products sold at low, low costs. So higher energy prices didn’t bleed into the rest of the economy in the same way.

The inflation resulting from the Covid pandemic was a more complex mix of factors. The massive amount of fiscal and monetary stimulus enacted by the US government and the Fed, respectively, created an environment of high consumer demand. Meanwhile, the breakdown of global supply chains resulted in a supply crunch. This combination had an effect on just about everything. And right in the middle of all this, in 2022, Russia’s invasion of Ukraine sent energy prices skyrocketing, though those came down fairly quickly from their highs as it became evident that sanctions on Russian oil were not having much of a restrictive effect on total global exports.

Dire Straits

And that brings us to the present. Unfortunately, the inflation that threatens to make itself known in the next few CPI reports has the potential to look more like the oil-related crises of the 1970s, and less like either the China supercycle or the Covid pandemic. There is still time for the worst-case scenario not to play out, and the most effective way for that to happen would be enough of a cessation of hostilities, or a ceasefire or whatever else you want to call it, to allow the Strait of Hormuz to reopen safely for shipping traffic. Even if that were to happen this week – even if the Strait is already open by the time you are reading this – at least some of the inflationary cat will already be out of the bag. The longer the present state of play continues, though, the harder it will be to manage the spillover effects into the larger consumer economy.

Exactly one week ago, the Bureau of Labor Statistics published its January report for wholesale prices, showing a 3.6 percent year-on-year rise in the Producer Price Index, much larger than economists had expected. Today, the same Bureau of Labor Statistics issued its monthly jobs report noting, rather coyly, that nonfarm payrolls had “edged down” by 92,000 in February. Now, perhaps whoever edits the BLS report wanted to soften the delivery of bad news for whatever delicate sensibilities might be perusing the jobs numbers, but a decline of 92,000, when economists had been expecting a gain of 60,000, is not “edging down” as much as it is a whopping clunker of a payroll figure.

Shutdown in the Strait

These two BLS reports bookended the other major news of the week, the attack on Iran by the US and Israel that has led to widespread disruption throughout the Middle East, including a near-total shutdown of shipping through the Strait of Hormuz, the narrow body of water between the Persian Gulf and the Gulf of Oman through which one-fifth of the world’s oil exports pass through. Much of that oil is bound for nations in the Asia Pacific Region. Local stock indexes in that region were quick to reflect the potential shock to the system. The Kospi index in South Korea, which had set a year-to-date high just last week, plunged by around 20 percent over the first three days of this week before stabilizing a bit by week’s end.

The immediate reaction of most world markets was somewhat less dramatic than the Kospi crash. Even oil prices rose more modestly on Monday and Tuesday than many observers had been predicting after the first US and Israeli air strikes on Saturday. But as questions grew in number over the week, without much in the way of coherent answers from those directing the operations, the “resilience” theme pronounced by many financial media sources gave way to mounting concerns that the disruptions could persist for some time to come. Stock markets are down. Brent crude oil, a benchmark standard, is currently around 30 percent higher than where it was before the war.

Shades of 1979?

Nominal bond yields are also higher, reflecting the inflationary concerns attending the rise in oil prices. As we noted above, inflation was already pointing higher before the air strikes began. And with today’s jobs report adding another data point to the case for a slowing economy, the specter of stagflation – slow or negative growth and high inflation – is making itself felt. Stagflation, rising bond yields, turmoil in Iran…this sounds an awful lot like 1979. That period of disruption led to a draconian monetary tightening program by the Fed and the then-deepest economic decline since the Great Depression. It would take three years before the economy returned to sustainable growth in the early 1980s.

It was in that year as well, 1979, that the troubles in Iran led to the establishment of a brutal theocratic regime that has terrorized its own people and the world at large ever since. Now there is at least a chance, a best-case scenario, that the Middle East war that started last Saturday will lead to a definitive end to this regime and its nefarious influence on proxies throughout the region. Much will have to go right for this to happen, a combination of smart planning and luck. We are not overly optimistic, but we will remain ever hopeful. A strong and democratic Iran would be a genuine asset – for Middle East stability, for the interests of the international community, and most of all for the Iranian people, who deserve the chance for a brighter future.

When Commodore Matthew Perry sailed into what is now Tokyo Bay in July 1853, the Industrial Revolution had already been galvanizing Western economies for a half century. Japan, by contrast, was an isolated feudal backwater, intentionally cut off from the rest of the world since the beginning of the Tokugawa Shogunate in 1603. Faced with the obvious technical superiority of the West as they stared down the cannon barrels of Perry’s Black Ships, Japan’s leaders realized that nothing short of a far-reaching transformation away from the ossified practices of the ruling samurai class was going to be required. Via the Meiji Restoration that began in 1868, they succeeded. By the end of the nineteenth century, Japan was a modernized industrial power carving out its own empire to compete with those of its Western peers. In 1905 it defeated one of those peers, the czarist empire of Russia, in the Russo-Japanese War and thus firmly established itself as a player in the great-power politics of the age.

The Takaichi Trade

The point of that little history lesson is that one should never count out Japan and its ability to reinvent itself. For the past thirty-odd years it has been easy to dismiss Japan as a once-strong economy whose time has come and gone. The Nikkei 225 stock index failed to regain its 1989 high point until 2024, 35 years later. Demography, deflation and debt summed up an economy listlessly drifting its way into senescence, stubbornly clinging to a shopworn model while the rest of the world raced ahead with successive generations of game-changing technologies.

But recently, the country seems to have shaken off the malaise of these so-called lost decades. That long-suffering Nikkei 225 index has gone from also-ran to world-beating over the past twelve months.

A good portion of this outperformance can be attributed to the emergence of a new political star. Sanae Takaichi is a rarity in the world of Japanese politics in two ways: first, she is a woman, the first of her gender to attain the office of prime minister; and, second, that she is wildly popular. Her initial victory last October sent the Nikkei surging, even as the Liberal Democratic Party (LDP) that she heads struggled to piece together a coalition government. It surged again earlier this month when a snap election audaciously called by Takaichi resulted in an LDP victory of historic proportions and a clear green light for the new government to move ahead with its mandate for sweeping economic reform.

The Takaichi Trap

That mandate, though, is not without some potential headwinds. The Takaichi government seeks to implement a major stimulus program to reinvigorate industry, catalyze consumer spending (for example, by eliminating a consumption tax on food products) and establish a stronger geopolitical presence in the region. This last item, which implies a big investment in Japan’s defense industry, has already created some waves after Takaichi made some supportive remarks in favor of Taiwan, remarks that provoked pointed criticism from China. As for the stimulus measures, they are going to have to contend with the Bank of Japan’s attempts to normalize monetary policy and keep a lid on inflation, which has made a somewhat surprising return in the past couple of years. Japanese bond yields have experienced some wobbles of late, as investors try to figure out how the BoJ and the Takaichi government are going to harmonize their respective agendas.

Remembering Shimonoseki

It is, of course, possible that the best laid plans of the Takaichi government will fail in its attempts to re-establish Japan as a highly productive and energetic economy with world-class products and services. But, as we noted above, it is never wise to count the country out. Reaching even farther back into the annals of history, in the late thirteenth century Japan was besieged by the superpower of the day, the Mongol empire of Kublai Khan. After a first encounter in which the Mongols gained some territory but then backed off to regroup, the Japanese built fortified protections strong enough to withstand future assaults. Attack again the Mongol fleet did, but it failed to penetrate the fortifications, and while the fleet was stranded in the straits of Shimonoseki trying to advance, it was destroyed by a great typhoon – the “divine wind” the Japanese translation of which is “kamikaze.” The Mongols never attacked again.

Japan is a highly conservative society with a pronounced resistance to change. But when it puts its mind to it, the country has shown in the past that it is capable of remarkable change in a very short period of time. As nations around the world grope for position in the changing global order, it may be time to give Japan another, closer look.

The rotation out of US equities is into its second year and going strong. The rest of the world may be having its share of problems, but underperforming stocks is not one of them. Here is a brief snapshot of how things are going in other parts of the globe, relative to the flattish ways of the S&P 500 thus far.

This got us to thinking about the last time non-US equities gripped the imagination and enthusiasm of the investing crowd. Let’s take a little trip back to the quaint world of this century’s first decade.

Swan Song for the Global Age

In hindsight, we know that it was the last gasp of the Global Age – the final five years of the quarter century in which the neoliberal trinity of open borders, light-touch regulation and unconstrained capital reigned as the unapologetic Zeitgeist. But for those of us living in those years, sandwiched in between the dot-com crash and the global financial crisis, 2003 to 2007 was just another chapter in the “end of history,” briefly interrupted from late-1990s good vibes by said bursting of the tech bubble, but with the Clinton-era directive to not stop thinking about tomorrow still circulating endlessly in our limbic regions.

The US dollar, which had risen steadily during the world’s love affair with everything dot-com, held its own during the 2001 recession, but started to falter the following year, setting the stage for what would become the great non-US equity rally of the mid-aughts.

What caused the decline of the dollar and the related move out of dollar-denominated assets? Several variables were probably at play, including the simple fact that the late-90s tech boom was almost entirely a US affair, so a “sell America” impulse was natural when that play fell out of favor. But there was more to it than that. The outperformance by international equities of almost every stripe over their US counterparts was solid, structural and sustained over this entire five-year period.

This was the period when China’s fast-growing economy blasted into its supercycle phase. Observers suddenly realized that all those jobs which had left the US due to offshoring in the 1980s and 1990s were not reappearing all over the world as hubs in an increasingly complex global supply chain. The word of the day was “decoupling,” as in the growing independence of these emerging regional clusters without the need for depending on capricious portfolio investment from Western capitals. The non-US world, and especially the emerging parts of that world, were destined to grow faster than the established West. Faster growth would mean more prosperity and, sooner or later, companies that would be every bit as good as, if not better than, their Western counterparts.

Decoupling Arrives, Twenty Years Later

Things didn’t work out that way, as we now know. The global financial crisis knocked all stock markets for a nasty loop, and the Great Recession set in. The Eurozone nearly fell apart in the early 2010s. China’s supercycle ran out of steam in the middle of that decade, prompting a major devaluation of its currency and a collapse in Chinese equities. Meanwhile central banks, led by the US Fed, took over the job of rebuilding the economy by providing ultra-cheap money. That easy money, in turn, catalyzed animal spirits in Silicon Valley to invest in audacious tech projects, some of which became extremely successful. US assets were back in favor, led by the tech giants and some of the smaller pilot fish that swam along in their wake.

Finally, though, the decoupling moment that had been imagined back in the mid-2000s arrived, last year. The old Washington Consensus of a global village unified under the neoliberal banner of free trade, judiciously overseen by the US, is gone. China is ascendant, Europe is regrouping into a post-Pax Americana order, and even Japan is showing some moxie again as the country rallies to its new and extremely popular prime minister. What all of this is going to look like five years from now is anybody’s guess. But the composition of global asset markets is likely, we think, to be quite a bit more diversified than it is today.

What’s going on in the US jobs market? Over the past couple weeks, we have received a deluge of data points about job openings, layoffs, payroll gains and – the one most people think of when someone says “labor market” – the benchmark unemployment rate. What this truckload of data has not done, though, is offer a clear picture of the current state of the labor market.

Oh, and then there is one more data point, which is the tanking stock prices of a whole bunch of companies that was the subject of our commentary last week and which has spread into more industry sectors since then. We’ll get to this, which is inevitably about AI, below. But first, the headline numbers.

A Cool Front, not a Cold Front

The one conclusion we can all probably draw from the above chart is that the overall trend in the labor market is cooling – it’s not heating up. Over the past four years, the unemployment rate has risen by about a percentage point, give or take, while the pace of monthly nonfarm payroll gains (the green columns in the chart) has declined. Indeed, nonfarm payrolls have declined in four months out of the total going back to January 2025. According to the revisions published this week by the BLS, the total number of job gains last year was reduced from 584,000 to 181,000. That’s a big drop.

On the other hand, the January 2026 numbers, which came out this past Wednesday, were much better than expected, with nonfarm payroll gains of 130,000 (versus economists’ forecasts of 75,000) and a drop in the unemployment rate to 4.3 percent. But there are several caveats to what appeared to be a blowout January jobs report. If history is any guide, these numbers will be revised at some point in the near future, and that could mean lopping off quite a bit from those 130,000 NFPs. Then there is the issue of where all the gains came from. It won’t be surprising to anyone who has been following the BLS reports in recent months that virtually all of the gains came from healthcare and the related field of social assistance – 124,000 jobs combined from those two sectors. Most everywhere else was some mix of slightly up, slightly down or flat.

Then there are the other recent reports from private sector sources. Perhaps the most eye-popping here was last Friday’s layoffs report from the firm Challenger, Gray and Christmas, showing that US companies posted the highest level of layoffs last month than at any time since January 2009, which you may recall was at the depths of the most brutal economic reversal since the Great Depression. Ouch. There were also some anemic numbers posted that same week by the ADP employment survey and the JOLTS report of job openings. The number of job openings, according to that report, was the lowest since September 2020 (which date should bring to mind yet another period of economic and social turmoil).

All told, then, the picture is inconsistent. Some of the numbers seem dire, others mildly negative, and a couple (e.g. the January NFPs) that one could use as a case for the “green shoots” optimistic types always like to trot out when they see light at the end of the tunnel or a similar shopworn cliché. We probably are closer to reality when we note that conditions are cool, but not yet cold.

The Ghost in the Data

But will the cooling trend stabilize, or are we about to get belted by a nasty polar vortex of labor market disruption? Many stock market investors seem to have made up their mind that the AI jobs apocalypse is here, a clear and present danger. The rout in software-as-a-service shares last week spilled over into a swath of other sectors this week including wealth management (that hits close to home) and brokerage services. The carnage spread even to some behemoths of the sector like Morgan Stanley, unlikely as it might seem that a firm of that size and stature could be brought low by some AI black box that eviscerates every legacy job in its path.

But that seems to be the vibe, thanks largely to recent product launches by firms central to the AI narrative like Anthropic and Google – these tools are apparently so incredible that they will automate everything, and the incumbent players who have been slow to reconfigure their operations from top to bottom will be shut out. To be clear, we think the current indiscriminate selling in the market is an overreaction, and shares in the companies affected will stabilize and recover at some point soon. However, there is probably at least a grain of truth in the potential these AI tools have to threaten the livelihoods of workers in these and other industries. It would be wise not to take too much comfort in the January job numbers as a sign of green shoots.

Silver and gold, silver and gold, sang Burl Ives as the Claymation snowman Sam in Rudolph the Red-Nosed Reindeer (apologies, sort of, for the earworm). Anyone who bought silver and/or gold a couple weeks ago is probably not singing a merry tune this week, as the price of these precious metals commenced a precipitous plummet last Friday that has continued into this week. The gold bugs can at least take comfort in the fact that they’re not alone. A wide swath of folks from crypto enthusiasts to lovers of software-as-a-service companies and hyperscale AI titans are feeling an unusual amount of pain as financial markets have shifted into an abrupt reverse. Yes, the S&P 500 is up in early morning trading today (heaven only knows where it will be by the time you are reading this). But the sentiment is edgy, to say the least. The CBOE VIX index, popularly known as Wall Street’s fear gauge, is back above 20, signaling a high degree of skittishness among market participants.

Several Walls of Worry

There may not be much commonality between the nosedive in the price of silver, say, and the problems facing tech stocks. Or is there? We’ll come back to that in a bit, but let’s talk here about the week in tech, because it has been unusual. Two prominent Magnificent Seven companies, Alphabet (parent company of Google) and Amazon, released earnings reports that could only be called blockbuster – not only beating analysts’ estimates for sales and earnings but raising forward guidance and demonstrating strength in their core strategic franchises. Both stocks are down, though, with Amazon off nearly ten percent in trading after the release of its report earlier this morning. The culprit? Among the blowout numbers reported are big, big increases in planned capital expenditures, mostly to continue funding AI infrastructure buildout and well in excess of what Street analysts had been expecting. The huge costs associated with chasing AI supremacy seem to be, finally, weighing on investor sentiment.

Why now, though, since stratospheric capex has been a central theme in the AI story for many quarters to date? It might have something to do with another wall of worry in evidence this week, in the form of a chap named Claude. Well, an AI model named Claude, which is an offering by Anthropic aimed at revolutionizing business and knowledge processes for enterprises, notably those in publishing and legal services. The problem, or at least the catalyst behind a lot of selling in the software space this week, is that Claude’s demonstrated capabilities in AI agentics could kneecap the companies that provide software as a service to these very same legal services and publishing companies, and presumably enterprises in many other industry spaces as well.

Now, to bring these two walls of worry together, the software-as-a-service companies caught in the wake of the Claude splash are also big clients of the data centers served by the AI hyperscalers like Amazon and Alphabet. All of this seems to have investors wondering who is going to benefit, ultimately, from all the capex spend and who is going to end up with a big fat negative return on investment. The AI story got a lot more complicated this week, and it is showing up in lots of different places.

Everything Is a Prediction Market

Returning to the broad-based carnage across many asset classes this week, is there anything that might serve as a thread running through them all? In traditional times, gold was regarded as a hedge asset. If you didn’t like the way things looked in the world, if the stock market seemed overpriced or the US dollar looked weak, or wars looked like they might break out, gold was where you might seek some refuge from the perceived coming storm. Indeed, for much of the past twelve months we have been hearing a great deal about gold as a hedge from financial media types.

But were people really buying gold as a hedge, or were they buying gold because everyone else was buying gold? Same for silver, same for bitcoin and other cryptocurrencies. Probably a bit of both, but we shouldn’t ignore the speculative impulse behind much of what drove prices higher, particularly this year. At its peak on January 26, silver was up 63 percent for the year to date. In other words, 63 percent over the course of 26 days. As of this morning it’s up just eight percent. Gold, in a somewhat less dramatic fashion, peaked at a gain of 23 percent before shedding 15 percent in a matter of days.

All at the same time that risk assets like stocks were falling. Not much of a hedge there, huh? It’s easy to speculate, though, when taking a position in gold (or silver, or bitcoin) is as effortless as, say, taking a position on the outcome of the forthcoming Seahawks – Patriots showdown, or how many field goals will happen in the third quarter of the game, or how many minutes into the game the first Bud Light commercial will air. Everything is a prediction market now. Including mainstream finance. That, quite possibly, is the thread running through assets of many different flavors.

It is something of a rarity when a single week contains both a policy meeting by the Federal Open Market Committee and the announcement of a selection for the next Fed chair – and that same week winds up being one of the most boring and least drama-filled in recent memory. After weeks of theatrics around the current dramatis personae of the Fed and their interest rate decisions or their office renovations or the minutiae of their personal mortgage applications, with page after page of financial media op-eds breathlessly debating the existential precariousness of an independent central bank and its place in the modern world – after all that, we get two things this week, neither of which raised ones’ blood pressure.

No Urgency on Rate Cuts

First, a very uncontroversial decision by the FOMC to leave interest rates where they are, a decision that had the same effect on markets that a reading of “Goodnight Moon” has on a sleepy child. The S&P 500 closed at 6,978.03 on Wednesday, the day of the FOMC meeting. That was exactly 0.57 points away from the level of 6,978.60 where it had closed the day before. The decision to hold rates was widely expected, the Powell press conference said little that hadn’t already been said (while Powell himself deftly deflected the many questions launched his way about subpoenas, cost overruns and other political chicanery). The stock market, which has a habit of lurching all over the place during these post-FOMC press conferences, drifted along while bond yields barely budged. Nothing to see here.

A Conventional Pick

The second event, as we all learned this morning, was the selection of Kevin Warsh to replace Powell as Fed chair when the latter’s term ends in May. As is customary with the orchestrations of the current White House, the process of selecting the next Fed chair was heavily weighted towards reality show optics, with the only constant seeming to be who could say ZIRP (zero interest rate policy) the loudest and with the most conviction. In the end, though, the man picked for the job (who will still have to clear the bar of Senate confirmation before he gets to measure the curtains in his Eccles Office Building chambers) was arguably the least controversial and, having already had one stint as Fed governor some years ago, the most familiar to Fed watchers. Warsh has his fair share of both supporters and detractors among economists and media analysts. But he was a far more conventional pick than one might have expected from this government.

What Happens Now?

A couple things have happened in the markets since news of the Warsh pick came out. The hot take seems to be a move out of inflation-hedging assets, and none more so than precious metals, the hitherto darlings of the 2026 trade. Gold is down by more than six percent this morning while silver, which has captured the fancy of the speculators this year like nothing else, is off by more than 13 percent after a couple hours of trading. Don’t feel too sorry for the long-silver crowd though, as they are still cushioned by year-to-date gains of 40 percent even after this morning’s carnage. Meanwhile the dollar has stabilized a bit and interest rates are holding close to where they have been recently.

Of course, this game is still in very early innings. Back to the substance of the FOMC meeting this week, the overall state of the economy is, well, more or less okay. Powell noted that policymaking is still complicated somewhat by the persistence of above-target inflation and a cooling jobs market. But the main gauges of both inflation and unemployment remain in yellow-flag territory and well away from anything signaling clear and present danger. It will probably help, in the short run, to have fears of an overtly political Fed and the attendant specter of hyperinflation taken off the front burner. Hey, when it comes to monetary policy, we are huge fans of as little drama as possible. But there are plenty of dragons lying in wait for Kevin Warsh, once he comes out on the other side of the Senate hearings.

Imagine if they had Polymarket and Kalshi 150 years ago. What a time the speculators of the day would have had! In 1876, major disturbances broke out all over the Balkans as people rose up, in a generally sporadic and uncoordinated fashion, against their nominal overlords running the Ottoman Empire. An uprising in Bulgaria was particularly brutal as a small band of nationalists was crushed by Ottoman troops and massacred in grisly fashion. These disturbances worried the Great Powers of the day, with Russia and newly-united Germany in particular swooping in to either try and restore order or grab a bit of land and influence where the opportunity presented itself. Serbia and Bosnia were also waking up to nationalist sentiments that would reach fever pitch in the years to come.

Prediction Markets Mania

Of course, there was no such thing as digital prediction market platforms back in the 1870s, so there was no way for, say a Vienna-based punter to make an overnight killing on the likelihood that the Ottomans would accept the establishment of an independent Bulgaria, or the odds of a Bosnian revolt against the administration of their affairs by Austria-Hungary. Today, though, these user-friendly market platforms are in full swing as the Western world reverts to the mores of Great Power politics.

And what happens on prediction platforms like Polymarket doesn’t stay on Polymarket, but jumps like a charged electron up a level or two to exert pressure on flesh-and-blood securities indexes like the S&P 500. That index was all over the place on Tuesday and Wednesday as investors placed their bets on the likelihood of a Greenland invasion, or the follow-through with another round of punishing tariffs on Europe. When, in the middle of a rambling and incoherent speech on Wednesday, the three-word chain “won’t use force” manifested, the reaction on the stock indexes was immediate, and those who had placed “no invasion” bets on Polymarket cashed in their chips. For a textbook illustration of how financial assets move in the world of today, one could do worse than to study the minutiae of Tuesday and Wednesday this week.

Lots of Events, Absence of Vision

Polymarket, Kalshi and their ilk are called “event contract” platforms, a bit of technicalese meant to distinguish them from (heaven forbid) gambling sites. They are fast becoming a central part of the mainstream financial market infrastructure. Fortunately for their executives and shareholders, there are plenty of events to wager on as this new geopolitical era dawns. Few people imagine that Trump’s speech on Wednesday marked the last time Greenland will be in the news, but never fear, there will be other “events” in the weeks ahead. And because the data around these bets (sorry, “event contracts”) tend to get instant visibility in the financial media, they have the ability to validate an imagined future outcome before the nuts and bolts behind that event have been deliberated on by those involved in and responsible for negotiations around it. We run the risk of pinballing from one crisis to the next without any kind of through-line to connect the dots. This adds a whole new dimension of risk to what observers like Adam Tooze, the Columbia professor and author of the widely-read Substack “Chartbook” call the “polycrisis,” the simultaneous presence of crises on multiple fronts, about multiple things.

This lack of vision brings back to mind those unsettled days in the Balkans in the late 1870s. The tumult seemed to die down in 1878 with the Treaty of Berlin, an ambitious attempt to keep the Ottoman Empire from completely collapsing while at the same time giving nationalists in Serbia, Bulgaria and elsewhere a bit of opportunity to express themselves but within the strictures of administration and guidance from the Great Powers. In a practical sense – though only a handful of observers realized it at the time – the Treaty of Berlin set two of these Great Powers – Tsarist Russia and the Hapsburg Empire of Austria-Hungary – implacably against each other. Germany, worried about Russia’s encouragement of pan-Slavism in the Balkans, bound itself to Austria-Hungary and then with Italy in a Triple Alliance. The bonds between Russia and France tightened at the same time and would eventually lead to the Entente Cordiale between these two countries and Great Britain.

The Concert of Europe – a global order that had managed, more or less, to keep the peace since the end of the Napoleonic Wars was thus replaced after the Treaty of Berlin by the formation of two great-power alliances that became ever more belligerent and defensive as Europe reeled from one crisis to the next, in the Balkans, in Algeria and elsewhere, before it all blew up in 1914. Such are the risks of the great power mentality that we appear to have stumbled back into. We are going to be in need of clear, strategic thinking as we move towards whatever the new world order is going to be – and we would be well advised to pay little heed to what the Polymarket “odds” that seem to accompany every news story of geopolitical import tell us.