AI Adoption and Future Bank Risks

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This is a job for indeed sponsored jobs. evil then that building is heilled Welcome to Profperty Markets. I'm Ed Elson. It is july fifteenth. Let's check in on yesterday's market vitals The major indices climbed on a better than expected inflation report, moreore on that in a minute. The inflation reading also sent treasury yields lower. Meanwhile, Brent Crude declined after President Trump scrapped his idea for a twenty ccent fee on cargo in the Strait of Hormuz And finally, IBM plunged twenty five percent after pre announcing earnings that missed expectations It was its worst day of all time Okay What else is happening Inflation cooled to an annual rate of three point fivealf percent in June, which was lower than economists had predicted. Consumer prices fell zero point four percent between May and June. That was the largest one month decrease since april twenty twenty Much of that drop was driven by lower energy prices after the US. Iran ceasefire eased fears of supply disruptions, but that relief may be short lived Last week, of course, President Trump declared the ceasefire over. And yesterday, the U. S. launched a new round of strikes on Iranian targets. Brent Crude has since climbed back to around eighty five dollars a barrel, raising the prospect that energy prices and inflation could move higher again joining us to discuss this inflation report. We are speaking with Mark Zandi, chief economist at Moody's Analytics Mark Great to see you. Thank you for joining us on the show Inflationations come down. We were at four point two, which was really high. now down to three point five still pretty high, but lower than expected. I think the bigger question though is how much of that was because oil prices went lower in June. And I ask that because oil prices are, of course rising again, which makes me think maybe this is not here to stay. Yeah. it's odd when you said inflation is easing to three point five percent. You know it is easing. It's down, but you know, it's still awfully high, uncomfortably high. you know as everyone knows the feds target would two percent inflation, that's kind of what take is being a comfortable rate of inflation. And I think under what I'll call underlying inflation, kind of abstracting from all the vagaries of the data. And by the way, in this report, there was a lot of noise. I don't know if you noted, but it was a very noisy report And you know, a lot of anomalies in the data, and I'm not sure how much to read into it You know, abstracting from that. I think underlying inflation is Kind of three to three and a half percent somewhere in there. Ag, uncomfortably high And that's abstracting from the swings in energy prices related to the war. whichich obviously added a lot to inflation coming into the war back. the spring, early summer and is now detracting from inflation But abstracting from that, you know we're at a very high uncomfortable level of inflation. And this is after a number of years of very high inflation. In fact, inflation's been above the Fed's target for five years. And so the cost of living is extraordinarily high. reflects the cumulative effect of those high rates of inflation. And I think people just are feeling very uncomfortable with that. And hopefully the Iran war moves in the wrong right direction here and begins to abate. But as you point out, that's now a new risk. I think the big question is Is this going to be the trend? Will we keep seeing the number go down And that's what I'm trying to understand from this report Does this tell us that inflation is now headed in the right direction specifically down, or is this A bled becausecause what we know about last month is that you know, specifically when we look at the energy markets peopleeople seem to think The war was over. Now here we are in July. prices are going back up people seem to think No, it's not because the president told us as much. I mean, obviously a lot depends on what the president does or doesn't do and whether the strait reopens and we get oil flowing through or not. I mean, I think the only there's no way to know for sure, obviously given the ups and downs and all the aroundounds here You know, I think the most likely scenario is that the incentives here for the president and the Iranian regime to figure this out and open up the strait over time and get oil flowing, get oil prices down are pretty high and that they will figure that out. Obviously, I say that with no confidence. this can go in a boatload of directions. And if we just assume I'm right, oil prices come down and inflation continues to come in It'll be it'll take time. It's not going to come in fast. It's going to be a sticky. You know, I think that There's a lot of other things going on here. know Artificial intelligence is juicing up inflation, immigration policy is juicing up inflation There's just a lot of slew of things going on that suggest that while inflation will come in, assuming the Ron word sticks roughly to script It's not going to come in fast. It's going to come in slow and sticky and it might not be a couple three years before we get back to anything we all feel comfortable with. Do you expect that three and a half will it'll go up r three and a half over the next few months, it'll go down. I mean what directionally where do you think we're headed? I think we're directionally lower. again, assuming that you know the Iran war doesn't go off the rails here and oil prices stay where they roughly where they are, let's say, eighty eighty five bucks a barrel then I do think we will see it come in because the other thing to consider on inflation that's really fundamental is is the job market. you know, that that goes to wages and cost of labor. and that is the single most important driving force of inflation. And right now the labor market is soft. you know, we saw that in the last jobs report. We're not creating a whole lot of jobs and there's a of there's slack in the labor market that's continuing to increase. That's putting downward pressure on wages. Wage growth is below the rate of inflation and slowing across All different wage groups and that you should ultimately drive the rate of inflation lower. But again, that's a process. that takes time. That doesn't happen in a month or two or three. That happens in a year or two or three. Just looking at the US inflation rate compared to other nations, we currently have the highest inflation rate in the G seven which is interestnteresting because it seemed as though We were kind of the most sheltered from what was happening to U oil prices as a result of uh, the Iran W But now I guess that's not really the case. I mean, what do you make of the fact that we're actually in a worse spot now than many of our peers? Yeah, I think that goes to the fact that most other countries provide subsidies or regulate the price of energy. They don't let it pass through. You know the Europeans don't let it pass through. Some countries do, know some Asian countries, but most don't very different in that the as soon as oil prices go up, our cost of gasoline, diesel jet fuel goes immediately up. Now there's P problems with that and that is, you know we're all struggling with lower purchasing power. Our real incomes are declining and it's hurting the economy The benefit of that is we adjust a lot more quickly. We, you know, we pull back on our driving, you know, we fly less, you know, we become more efficient in the use of trucks that deliver packages to our door. The rest of the world, there will ultimately be a pass through, but it just takes a much longer period of time for that to occur. The thing I might be going on to help explain and this is a little more problematic is lack of competition, you know, competition in different industries has eroded over time. An increasing number of industries are dominated by a few companies that can set prices more significantly or able to hold their pricing for longer in the face of weakening demand or slower costs of doing business And so that lack of competition, which has I think, occurred over the years and become more pronounced Now may may be also playing a role in the higher rates of inflation that we're seeing here and the fact that maybe why inflation the reason why inflation might be more sticky here Because businesses are under less pressure to cut prices because of the lack of competition or the less lessening of competition Kevin Warsh New Fed Chair spoke to Congress. He said the CPI drop does not mean quote, mission accomplished on inflation It seems to be A lot more hawkish. than people expected? I, what do you make of his statements What do you think? u This means for interest rates going forward Yeah, I've been surprised at how as you say, haawkish she has been, you know going back to the FOMC meeting, the policy making committee meeting He used the words price stability several times, you know, and he convinced Investors that he's serious about that if you look at inflation expectations and what B Ben investors think inflation will be in the future, they came back down and back to where they were prior to the Iran warar And so they're convinced that he's going to work hard to keep inflation down. That's his primary focus And I take a great deal of solace in that because six months ago when we were having these conversations, I was much worried about the Fed's independence and that whoever the Fed chair was going to be could buckle under the weight of the pressure from the president who says he wants lower interest rates I feel less worried about that. We'll have to see, you know, obviously there's we'll have to see how this plays out and there's a lot to be learned. But so far so good. And I think that feels very good. Now does mean the potential for higher rates. I mean, markets are now anticipating Last I looked might come in today with these better inflation numbers, but last I looked two rate increases, quarter point each time And so the investors are expecting that that hawkish rhetoric will translate into higher interest rates. And you know, the one of the side effects of more hawkish Fed chair is you're going to have higher rates for longer. But I think ultimately you know, the key thing here is fed independence and I feel much better about that in the wake of all the things that Kevin Warsh has done since he's been appointed. Do you have a view on the path for interest rates for the year ahead? I mean, this seems to be like the biggest question for investors. willill rates go up or down or will they stay flat? and People have been debating this since the beginning of the year. Everyone seemed to agree they were going to come down heading into the year. That's changed now Do you have a view on that debate? Yeah, Corset, I've got lots of views. Yeah, evenven on the World Cup, I got a view. so O will the Phillies series? Yeah. I got Yeah, I got a view. It's a bit out outside of consensus. I don't think the Fed's going to raise or or lower rates. I think policy will remain unchanged because I do think, you know, they have two mandates. One is low and stable inflation and that's what we've been focused on. that would call for higher rates. But the other mandate is Full employment and there the job market in, my humble opinion is soft. It's weak. I mean, we're not creating any jobs All the jobs we're creating is in the healthcare sector. It's very narrow If you lose your job, you're in big trouble because you can't get hired back. hiring rates are very low. The share of the unemployed are unemployed for long periods of time is now rising and very high. Wage growth is very weak. And so I worry that There's slack in the labor market. You don't see in the unemployment rate because labor force is collapsing. peopleeople are leaving the labor force And you know, if the labor force participation rate had just remained unchanged over the past year, the unemployment rate would be five percent. And we'd all be talking very differently if it was five percent. And so I think the job market is very soft. and I think ultimately that will convince the committee not to raise rates. But you know Like many things like which ways this we're going to go, I say this with low levels of confidence because you know, obviously there's a lot of uncertainty here. Right. It seems like the question is As usual which one is more of a problem I think I tend to are on the side of the inflation problem is more of a problem because I'm personally very worried about what we're seeing in terms of the Iran situation. But I take your point and you said this Recently on social media, you said that the commentary on the employment report for June was, quote, much too dismissive of how weak the numbers looked. And so I guess we find ourselves in the same position that the Fed always finds itself in, which is you gotta choose Well although we they're pushed into this really place, right? I mean because of policy. I mean because of the terrorists, because of immigration, because of the war That leads to weaker growth and higher inflation. That's stagflation. This is a stagflation environment. And what do you do with that at the Fed? Do you focus on inflation or do you focus on growth And it's a very tough spot to be in and that's the situation they're in. My sense is they punt and they say, I can't figure out which one to focus on. I'm not changing rates, but I hear you. I mean, you know, at the end of the day, push comes to shove, they've got to focus on inflation. Now I think the deciding factor ultimately on that will be inflation expectations. If inflation expectations stay down, then they may be able to get away without raising rates because inflation should come in. If inflation expectations start to rise say, you know, right now inflation expectations are based on the expectation the Fed iss going to actually raise rates. Now let's say that they say, okay, we're not they're not raising rates. So inflation expectations start to rise. Therefore, they got to raise rates. I mean so I know that's mind numbing, but that's the way this all works. It does make your head spin like Yeah ye it's like a haul of mirrors. Yeah All right, Mark Zandy, Chief economist at Mood' Analytics. Mark, appreciate your time. Thank you. Thank you After the break. Wall Street banks make a killing again And for even more markets insights, you can subscribe to my weekly newsletter simimply put at simply put. profgmedia. com. wishing you could be there live for the big game, soaking up the atmosphere in the crowd Too often, life gets busy or the price old you back Priceeline is here to help you make it happen. With millions of deals on flights, hotels, and rental cars, you can go see the game live. Don't just dream about the trip. book it with prriceline. Download the prriceline app or visit priceline. comot Actual prices may vary limited time offer intntroducing Ma gllasses. You have questions, they've got answers Hey, Meta, what's the capital of Peru? Lima, how do you say, Where's the restroom in Spanish? Dones Talvano. Hey Meta, is a hot dog a sandwich? Technically no, spiritually? Yes. Hey, Meta. What should I do with my life? That's one of life's biggest questions What do you think Ask anything with the new metaglasses If roaches are getting comfortable in your home, it's time for STEM's multiintsect spray. Made with botanical extracts, it's safe to use around people and pets when use as directed. killing ants, roaches, and flies without the fuss. And with no added dyes, fragrance, or harsh chemical odors, you can spray it inside and outside your home Live life never bugged, but stem. Visit stTemforbugs. com to learn more. We're back with Profty Markets. Five of America's biggest banks just reported earnings and they all delivered the same message. Wall Street is booming. JV Morgan beat on the top and bottom lines with CEO Jamie Diimond announcing record revenues across every major business Goldman Sachs posted one of its strongest quarters in history, with profits up nearly eighty percent year over year And Bank of America, Wells Fargo and Citigroup all topped expectations as well Dving those results was a revival in deal making, including five hundred million dollars in fees from the largest IPO of all time, SpaceX But investors didn't reward the banks equally. Goldman popped nearly nine percent on the news. JP Morgan and Bank of America both rose about two percent while Wells Fargo and Citig Group fell two and five percent. respectively. So Here to tell us what Wall Street's blowout quarter means for the markets and for the economy. We are speaking with Saul Martinez, head of US. Financials Research at HSBC. Saul, thanks for joining us on proroperty Markets. Blowout earnings across the board Acording to Jamie Diimamond, it's quote, getting close to as good as it gets for JV Morgan and for basically everyone Why is it such a good time to be a bankro. Right now you have, you know, almost a perfect storm of good economic backdrop. a resrailian economy. High real rates, which is positive for the net interest margins of banks. and you're seeing a resurgence of Deal making activity, asset prices are going higher So you have a backdrop that is supportive of a wide wide range of businesses, everything from traditional banking, which is benefiting from goodood loan growth, good net interest income growth, good net interest margins But what was exceptional I guess, what was most exceptional I think about The results this quarter were the capapital Markets businesses Steel making is back in spades So this quarter investment banking fees for the five companies You highlighted it grew anywhere from thirty percent to fifty five percent year on year and it's a cross product. IPO activity, which is has been historically low, has rebounded And at the same time, M andA activity has been strong Um deebt issuance is historically elevated. And then on top of that, in what may have surprised more than that is on the trading side. So banks intermediate, trades, they finance institutional investors. And those businesses are also booming, especially equities which was up for for those banks anywhere from forty five percent to ninety percent year on year. And then so it's almost the perfect storm where trraditional banking, capital markets businesses are doing well and it's reflective of a good economic backdrop with high rates or higher rates than we've had in the past and a lot of deal making activity going on So just to go through some of these things that are going right. You've got the loan growth, you've got the phenomenal equities trading, which I mean, it basically sounds like clients invvestors are trading stocks more than double than they were in some cases or sorry, close to double what they were trading from a year ago. So that's booming. and I assume a lot of that is the volatility that's happening in the markets that ofing increases trading. M andA, the deal making and then of course the IPO's The most significant of which was SpaceX which all five of these banks were underwriters of My question, how important was that SpaceX IPO to these earnings? And how important will these future IPOs, namely open AI An anthropic be to these earings as well, or are they less important? Well, I mean, if you look at them in isolation, it's not they're not huge numbers relative to the total revenue numbers. So even even, you know, we don't know the exact , you know, fees collected by each individual bank But it helps the equity capapital markarkets business, but that's pretty small portion of the overall revenue stream. Now no, don't get me wrong. you've seen IPU activity more broadly rebound and that is helping investment banking fees generally. And you do have additional IPOs, large IPOs that could be coming which provide an additional tailwind possibly later this year and into early next year. So it's helpful. It's not the biggest driver. That said, there there are, you know you know, there are other There's a sort of a multiplier effect also from some of these transactions. know you mint a lot of billionaires, for example, with something like SpaceX and that provides opportunities for your wealth management business. There are trading opportunities around that. There's going to be index rebalances around SpaceX, which forces investors to reposition their portfolio. So your market making activity increases. So looking at the IPO fees and the investment banking fees in isolation on these deals probably tells you only part of the story. There's sort of a multiplier effect on a lot of these transactions, whether they're IPOs, or um you know, M andA transactions as well where you have a lot of that same phenomenon going on where they where it helps you in multiple of your capital markets businesses. So you're seeing that multiplier effect really take hold right now That might be a crude way to put it, but when stuff happens in the capital markets, that's a good thing banks One of the things that is happening that David Solomon pointed out was the AI infrastructure buildout. which has been a boon for the company, he pointed out all of these data centers that have belts and financed. and that's kind of interesting because you know, you could understand why, you know, Nvidia would be a winner of the AI buildout. You wouldn't immediately think of Wall Street. Why have they benefited from this buildout Is this sort of a similar answer to the prior answer. There's sort of a multiplier dynamic, right? We think about AI, there's sort of the first order O first order of magnitude is on the financing side. So you have banks Blendingmore, you have, u U you have more debt issuance. you have more debt capital markets issuance you have sort of an economic multiplier effect. It's not just the AI infrastructure companies, it's also the energy companies and other firms that benefit from that and there's there's, you know, financing, there's lending, there's there's, you know, there's a debt issuance you can there are opportunities to lend and then distribute them to some of those products for your wealth management clients. And on top of that, now you have IPO activity going. So you know, there's a tailwind there. You have wealth management opportunities for you know folks who are newly minted billionaires. So there's there again, there's u you know, there' think about banks, they provide, you know, wealth, you know a store of value with wealth management products and deposits When there's a lot of value creation, all of those things benefit. And I think with with the AI build out It flows back into into banks, whether they're investment banks or traditional banks in numerous ways. Jamie Diamond so he said This is as good as it gets. He later followed that comment up with a slightly more cautious statement. He said, quote, we just don't know how long it's going to last. could end or run out for these banks, what should they be worried about at this point It is hard to envision, you know, continued growth off of these base off of the base we're on And I think that that that is could be be a headwind for eventually be a headwind for some of these companies and for the stocks to continue to do well. I think the other thing I would just mention is a little bit more mundane and you saw it with Wells Fargo. We talked about loan growth being good. That is driving net interest income, which for traditional banks, this is the biggest revenue item But if you start to see deposit cost pressure, higher funding costs We have now have a one rate hike built into the forward curve. banks are growing, there's a little bit more competition. If that starts to eat away at the net interest income growth in the second half of the year and next year, that's also something that could Derail the positive thesis. And again, you kind of saw that with Wells Fargo today because that was one of the concerns that people had was funding costs and what itant what it means for net interest income growth Just one final question before we let you go. Jamie Diamond had some interesting things to say about JP Morgan's use of AI He said that in some discrete areas, AI had been used to quote reduce jobs by thirty or forty percent. U He then sort of amended that he said those employees were offered jobs elsewhere, but the net net is he's saying AI is reducing their reliance on people in certain areas I'd be interested to get your reactions to those comments and also this idea that AI could be used on Wall Street to O, replace people and two increase profits. It's a fair question. and I think that was in response to a question I asked of Jamie about AI Um Look, I think banks are in the early innings of their u adopting use cases. for AI. I you know, I think they're generally been focused on efficiencyhancements and cyber risks and and fraud Um B I mean, AI tools are advancing so rapidly that U you know, I think companies generally, not just banks have to look at whether existing organizational structures U, makeakes sense and what the right way to be organized and what the right headcount levels are I mean, you saw in late February block and I know block is very different than and JP Morgan, but they cut forty percent of their head count Um, basically ar you know, arguing that You know, Given the advancements of AI tools, the way they're organized should be very different and I think is is Banks, look at their organizational structures and their headcounts there There is a possibility that in some cases You know, there there could be U you know, there could be changes in how headcount is are constituted and right and I think companies generally and banks specifically will have to think about what the right way to be organized. is in how many employees they need Um That's not to say you're going to see massive headcount reductions It is something that I think all companies will have to deal with and and this is also a very politically sensitive topic, right? AI just generally speaking. So I do think management teams will have to think about how they you know, how they frame these discussions and and, you know, what the right level is and how they communicate that But it is a it is a potentially a, you know, something that could really enhance efficiency But exactly how it plays out in terms of organizational structure, right levels of personnel, right levels of personnel in which groups of the business, that is all you know going to have to play out you know, over time. I think one final thing here, Ed that I'd mention is that Jamie does argue that, you know, this will all get competed away. I think that's his argument that, you know, you know, some of the benefits will, you know, in a competitive sector will will get competed away. And I agree with that. point because, you know, I do think in a competitive market that happens, But excess returns can last a long time. And you know those who are first movers could have you significant advantages here All right, Saul Martini is head of US Financials Research at HSBC. Saul, we appreciate your time. Anyime. As we wrap up quick word on the CPI report that we just discussed with Mark. First things first, let's recognize this is Ns I would never come on here and celebrate higher inflation just to say I told you so. Inflation is the fuel of the affordability crisis. It is the difference between eating and going hungry for millions of Americans. So anytime the number goes down, that is a good thing. And no, I don't think that the BLS is lying. Having said that It would be premature to celebrate this becausecause while the number did go down What we also know is that the reason it went down is because last month Oil prices went down as investors anticipated a swift end to the Iran war, which, as of this week, has officially been proven very wrong. The memorandum of understanding is over. According to the presresident, the ceasefire is over. The Strait of Hormuz is blocked once again, and lo and behold Here we are in July Oil prices are again rising We're now up to do eighty five dollars a barrel. That is up. twenty percent from the prices we experienced in June, the prices which were, of course, reflected in that CPI report that we're now all expected to celebrate. no This isn't a great report. It's good insofar as it's a temporary sigh of relief But it's bad into ourars it is, a temporary sigh of relief. This is most likely in the long story of the Iran warar, the war that many had said was coming to an end that many must now admit is only just beginning on a brighter But unrelated note I will end this show with one final message. It's coming home Okay, that's it for today. This episode was produced by Claire Miller and Allison Weiss and engineered by Benjamin Spencer. Our video editor is Brad Williams. our research team is Dan Salon, Kristen O'Donahghue and Mia Slverio, and our social producer is Jake McPerson. Thank you for listening to Profty Markets from Profperty Media. If you liked what you heard Give us a follow. I'm Ed Elson. I will see you tomorrow