Interest Rates Are Rising. Can the Economy Handle It? | Edward Dowd

Stock market is hitting record highs. At the same time, the interest rates are going up significantly, making the cost of borrowing a lot higher. Meanwhile, a lot of companies, AI companies, need to borrow to build the AI infrastructure. Is this all workable? Today we sit down with Edward Dowd, who's currently questioning what's happening in the economy. I think raising rates would be a serious policy mistake. They'll quickly realize that and start cutting Spending is rolling over. The consumers tapped out all their COVID savings. We've been almost eaten up. Honestly, I think when we look back, the NBER, which is the official organization that calls for sessions, will probably likely start a call-in session sometime this year. We could already be one of XAI. I'm Siamak. Welcome to Market Insider. Ed, it's great to have you on. Welcome. Thanks for having me on Market Insider today. Appreciate it. We want to talk to you about your thoughts on the rates. The rates are going up and the Fed needs to raise the interest rates. And there's big impacts of, some people are talking about sticky inflation. You have a different opinion on what's going to happen to the rates. Can you tell us what you think and why? Yeah, so in the very short term, the Federal Reserve may raise rates. That would be a policy mistake in my estimation. What we have is core inflation is starting to go down. Housing is about 40% of the CPI. That's under pressure and rents are coming down. What really befuddled the whole situation was the war in Iran. It's a mini oil price shock. And it tends to reverberate very quickly in the price of oil. And it creates a little spike in headline inflation. The problem is it causes demand destruction on the other side. And the economy is already very weak. And it's, I think raising rates would be a serious policy mistake. They'll quickly realize that and start cutting later in the year and early next year. Inflation after COVID obviously ramped up because of all the money burning. It peaked out at 9% and it's been coming down ever since. Now, inflation is a, when inflation is coming down, it doesn't mean prices are going back to where they were pre-COVID. It just means the rate of inflation is decelerating. And that's what the central bank's key on. What are you seeing that you make the conclusion that the economy is slowing down? Well, XAI, all non-residential and residential construction is rolling over. We had a tremendous build out after the free easy money and a lot of the illegal aliens that came in. There was a lot of multifamily housing projects that were initiated, started, and now they're slowing down and rolling over. The biggest impact of the multifamily housing market has been President Trump's election and the stopping of the illegals into the border. And there's been a lot of self deportations and some deportations, but not as many as people might think. So the second derivative on that whole thing slowed and multifamily housing is under pressure. We overbuilt. We built as many units as we built in the 1970s when the baby boomers were coming on board. So that's gonna cause pressure on rents. Rents ultimately cause pressure on home prices. And we do have an affordability issue right now where many younger millennials can't afford to buy a home. And we have 60% of the homes for sale are by boomers who are not really willing to cut prices. So we're kind of in a stalemate. We track homes for sale versus homes sold. Over time, the two series kind of track each other, but right now we have an alligator job where there's a disconnect of about 600,000 homes for sale versus homes sold. So the real estate market is basically frozen. The weakness in pricing started along the southern borders. The blue cities are still holding up, but we expect them to roll over eventually as well. So housing is 40% of, it's called shelter in the CPI component. It's 40% and it's slowly going the wrong way. Well, it depends on your point of view. It's going the right way if you wanna buy a home and be a renter, it's going the wrong way if you're a landlord or a homeowner looking to sell. Are you seeing rents coming down or do you think the rate of the growth will be a lot less? Or is there gonna be potentially rents coming down? So rents, there was this time series that the data agencies used to compile is called new tenant rents. Suspiciously, they got rid of it a couple of quarters ago. But when Trump took office in the fourth quarter of 2025, new tenant rents started plummeting. And that was because there was a lot of self deportations. And people don't understand the extent to which the legal immigrants are putting pressure on rents everywhere, because they just weren't coming here and living in tents. They were getting government subsidies to get rent. And those rents helped. And some of them actually were finding out did buy homes with the assistance of the federal government. Believe it or not, there was a lot of fraud went on. So new tenant rents have been coming down, which are leading our work and our academic work has said that new tenant rents are leading independent for all tenant rents, which are leading the home prices. We made that call in the beginning of 2025 and it's coming to fruition. How long do you think this will go on? Like, is it gonna be a few years of rents coming down and the real estate market, are the price of homes coming down as well? Is that what you're saying? Well, there's two ways this can go. This could be, depending upon other factors, the AI bubble popping and what's going on in China. We're very negative on the China economy, which will have contagion in Asia, which will eventually get come here. If you go fast or slow, honestly, the faster this happens, the better it is for the economy because we'll come out of it that much quicker. The slower this goes, it's kind of just this languishing around and people suffering because they can't afford things. So I like to rip, I'm a big proponent of ripping off the bandaid, taking the pain and then the recovery, green sheets immediately repair because price will correct everything and then people will start buying household information. They'll start buying furniture, the economy will pick up. So right now it's going slow and it could accelerate at any moment, but right now it's kind of a trickle. It's a slow rolling rollover. The good news is incomes have risen a tad. So the affordability issue isn't as bad as it was in 2025, but it's still way above where it needs to be. Besides housing, what about the rest of the economy? There's a lot of talk about the data center build outs and also some manufacturing coming back and some investment going on into manufacturing and data centers. What are your thoughts on that? Well, you know, look, Donald Trump wanted to bring manufacturing to the US. There's still a lot of trade deals in process. A lot of these trade deals haven't even been ratified yet by their home countries. The EU, I think, and Japan are one. They need to be ratified. So yes, a lot of the deals have been announced, but the money isn't here yet and it takes a long time to permit a site, to get the money to the country, to build and bring jobs here. So it's a great plan. It's just that there's a valley in between and manufacturing jobs haven't really been exploding. A lot of the job growth has been in healthcare and education, which is not, I would argue, is a lot of it is not very productive. So, you know, the real economy, the consumer sentiment is in the tank. Spending is rolling over. Consumers tapped out all their COVID savings have been almost eaten up. And, you know, honestly, I think when we look back, the NBER, which is the official organization that calls recessions, will probably likely start a common recession sometime this year. We could already be one at XAI. You gotta remember during the great financial crisis, they didn't call the start, that they called the start of the recession December of 2007. You know, I remember during the great financial crisis all throughout that year in 2008, no one thought we were in a recession and no one called we were in a recession. It's always, by the time we realize we're in a recession, it's almost over, quite frankly. Now, you mentioned China, China's economy. Can you tell us what you're seeing there and how could it impact us here? So China started to have a serious demographic problem beginning in 2020. And now they're in a demographic decline. They're losing a tremendous amount of their population. It's going from working age into retirement. And they don't have a safety net there. So the spending profile of retiree in China is even worse than it is here. They go into, you know, and they, while they're working, they save a ton of money as well because there's no social safety net. So as they switch into that demographic spending, their internal consumption falls out of play. At the same time, the demographic bubble rolled over, real estate really started to roll over in China. And they, unfortunately, you know, a lot of people give them credit for being these 100-year planners. Well, they didn't plan too well. They built 20 to 30 years of housing in New York that have to be worked through. So this is just like what happened in Japan. It's gonna take decades to work through. So their internal consumption is a disaster. The good news for them for a while was that they had long-lived large construction projects that were continuing. But they're now rolling over tremendously. And we're now in the peak phase of their crisis. And they're trying to export their way out of it. Hence the trade war, we're seeing. They're trying to dump and export inflation to the rest of the world because they are the factory of the world, after, you know, the last 20 years of outsourcing to them. So they're in a big problem. They're trying to, you know, export their way out of it. The problem is Japan did the same thing. Japan has the size of China. And this has, obviously, global economic implications. And that's why we're seeing all these trade wars emerge. So as China is entering its peak phase, their net fixed investment really started to go negative year over year. It's the first time in the history of their, you know, the last 30 years. In the fourth quarter of last year, it had a little bump up in the first quarter, but it's rolling over again. And that's now, last month, the data we have was minus 9.7%. So they're in big, big trouble economically. And one of the things they care about the most in China is keeping their people employed so they can contain rebellion. They're worried about their own people. So the gig there is to keep people employed and busy. And they're having a problem doing that right now. So China has a lot of problems. And their biggest trade partners are Japan and South Korea. On both exports and imports. So that's going to cause problems in Japan. We're seeing problems with the yen, their economies and patterns. And it's going to, and so eventually this kind of has a staging effect, a slowing of growth in Asia, which eventually will equate to the U.S. So we see three big threats to the global economy. China entering its peak phase of this crisis, a housing problem in the U.S. and an AI bubble that, in my humble opinion, is in the process of having issues. Tell us about the AI bubble. What are you seeing there? I mean, there has been discussion that some of these companies want to slow down their models now that there's talks from different CEOs and different engineers inside these companies. What are you seeing in the AI space? Yeah, on my sub stack at Dad Beyond the Narrative, I wrote in July that it was, you know, like it was like 2 a.m. in the bar and closing time is around the corner. And what I meant by that was we were seeing a second derivative shift in the AI hype. Enterprises were starting to slow their spend because they weren't getting any ROI in what they were doing. There was open, we have open source competition from China and others, which was causing pricing issues. It's cheaper to buy open source models and people and customers were switching. So we're starting to learn that the AI compute is very, it's more like a commodity. And there was a tremendous amount of infrastructure bill that went into this. And the ROI started to become questioned for the return on investment. And so what we started to see this summer were bond spreads starting to widen with all of this, especially with the neoplasm hyperscaler. Their bonds started to become more prohibitively expensive. So financing was becoming a problem. So NVIDIA and the latest conference call started to extend terms. They were very little terms for their customers. So we could see that the bubble was starting to get questioned by the bond market. And so next year, there's supposed to be something like 300 billion of issuance by the hyperscaler to continue to build out. And that would actually compete with the US government. It's a tremendous amount of supply that needs to be pushed. So spreads are going higher. And then the spreads, once the financing gets prohibitively expensive, it feeds back to the whole assumption of what's the ROI. And then you have the open source commoditization threats. So the whole thing is starting to get questioned. And semiconductors, which is a gold rush, and they peaked out in June, and they're down 20% because there's fears that maybe everything's slowing in the AI complex. Then this post-labor day, we have this AI panic. A very well orchestrated post by a young former employee of both OpenAI and Anthropic that took off. And it seemed to many people to be a coordinated campaign to scare the legislators, which popped on board right away, to regulate the industry and create what I would call state-run monopoly. So right now, this week has been very instructive. I see a game of thrones emerging. We have the AI accelerationists on one end, which are probably just came out today and wants to keep going fast on AI. Then we have OpenAI and Anthropic, which are burning tremendous amounts of cash and they're not profitable, worried about their ability to continue to raise money in their IPOs. So they're running to the arms of government to regulate the monopoly. So this is where we are. It's very interesting and it's very exciting time. Do you think these events, like it's gonna slow down AI more? Or do you think that this was gonna happen anyways? Like the recent events, like they don't wanna develop it more. Do you think this would have impacted their business as much as, or do you think this will slow down their business or was it already slowing down? The bond market was already telling you. The bond market, credit markets always end the party in infrastructure build-outs on a new technology. That happened in the railroads, happened with electric utilities in the 20s and 30s. It happened with the dot-com boom and it's happening right now. The bond market was starting to realize the ROI and the profitability of this infrastructure build-out was probably not as robust as initially thought. So it needed a correction, it needed to slow down. It needed to wash out people who made the wrong decisions on the wrong capital structure and or technology, it needed to wash. This is gonna happen anyways. So it's a very clever maneuver by open AI and profit to help basically get, it's a quasi-government bailout under the auspices of a safety issue. It's a panic that regulators could give them. And again, when you run into the arms of the government, the question is always who gets to write the regulations? My suspicion is these companies wanna write the regulations. And the idea is you wanna regulate your competition out of existence under the guise of safety. And do you think they're gonna say our business is gonna slow down because of this regulation and we might need a bailout? Is that how you're seeing it? Well, look, if you were Dario and Sam Altman of Anthropic and Open AI, and you had raised billions and billions of dollars from investors on the growth of AI, and you noticed internally that you were starting to slow, wouldn't you rather blame safety issues and regulations than your own miscalculations? This is classic. Now, what about the bond market? What did the bond market do that you're saying it's cutting them off? Did the interest rates go up? How did that happen? Well, interest rates have been rising. So that's number one, just the rise in the risk-free rate was a problem because of the war. You gotta remember before the war, yields were coming down. And then as soon as the war started, yields started going up in the US. So that was becoming a problem, just the risk-free rate, because they then borrow money at a spread to that. What was more important was the spread to the risk-free treasury was starting to widen. CoreWeave just issued many billions of dollars worth of a five-year maturity, and the spread was at 850 basis points to the five-year, or 13%. 13% is junk status, basically. So the bond market was already starting to discount the risks that we were seeing from the fundamentals, meaning the open-source competition, the fact that this is becoming a circular financing problem, NVIDIA financing a lot of their own customers, the big mag seven tech stocks, financing their own customers. So it was becoming apparent to the investment world that maybe the revenue from AI wasn't gonna come as fast and as quickly as possible. And the companies themselves, the enterprises that would buy AI and use AI were starting to realize the return on investment wasn't as robust as thought. So it was all gonna slow down anyways. I think this is a very elegant maneuver, I mean, in its game theory, it's a maneuver by open AI and then drop it. Elon, when this first news hit on Tuesday, suggested this was a well orchestrated SIOP or an operation marketing campaign. But then he joined forces with them because I think if I was Elon, I would do the same thing. You wanna see if it's going this way, you wanna see it at the table. So this is really a game of thrones situation. Obama and Hillary Clinton have weighed in on the topic, Bernie Sanders. So they wanna marry government and AI on one side and then you have Trump and David Sachs and others that wanna keep accelerating the technology. And so we're gonna see what's gonna happen. But it's not good news for the investors in these bonds and stocks because uncertainty like this creates a massive worry and the stocks are already expensive. So I suspect the multiples on AI stocks to contract as this gets sorted out. And what about the bondholders? You mentioned that the interest has gone up significantly on these products and on these companies that are building data centers. And at the same time, there are products out there with the private credit market and a lot of people are getting significant returns. Do you think there is a chance for some of these bondholders to lose what they've invested? Yeah, that's absolutely going to happen. The question is what are the losses gonna be? What's the recovery rate? What's the pace of the downturn? Private credit's interesting. Private credit was already starting to have problems. Private credit was a big part of the financing of the AI infrastructure build. And private credit started to have problems in the fourth quarter of 2025 going into this year. They had some very famous bankruptcies, Tricolor Auto and First Brands. So people started to question the underwriting standards of the private credit industry. And they've had a massive amount of withdrawals from private credit funds. And they've thrown up dates because they don't have the liquidity. So the whole private credit industry is kind of frozen at the moment. There are deals getting done, but the flows are going the wrong way. And Horning's family in November of 2025 did a report suggesting that 50% of the financing of the AI build-on had to come from private credit. So if one engine of financing is having its own problems, that's one of the reasons, of many, that spreads are widening. So people demand higher return for the added risk. So it's all kind of conspiring to slow down. And then, of course, post-Labor Day, we have the safety concern. Now, going back to what you're seeing after. So you're seeing a major recession coming in the next few years, or this year, or you already think we might be in a recession. And what does that look like? Well, typically speaking, when you get a recession, first of all, stock valuations have never been this high. They're back to dot-com levels. So just from math and these valuation levels, 10-year forward returns on the stock market are zero, including dividends. Whenever you get to valuations like this, there's always a mean reversion. The question is, how quickly does it happen? If there's a recession and a credit problem, this could happen quick, and we could get a 40 to 50% drawdown in the stock market, which would not be the end of the world. We had one after the dot-com crash. We had one after the great financial crisis. It's not the end of the world. Resets valuations, and then from there, things get better. So I'm not calling for a crash in the stock market. It could go sideways and not have any returns for 10 years, or it could correct pretty quickly. The way these things work, though, is usually there's some sort of problem in the credit markets, which we're starting to see, and when that happens, stocks take a hit. So it could happen. I think it's already begun. This could unfold over the next six to 12 months. And does it cause people to lose jobs? How does it impact people? Yeah, so the knee-jerk reaction is there will be layoffs. There will be a scaling back of the means of production, which are people, unfortunately. And then, like any recession, first, it's a jobless recovery. Then jobs start 18 to two years later after the recession. So some people may be left out of the game for a while, but this is what happens in every recession. And what do you think of AI? Because we were told that it will enhance productivity a lot. Do you think AI is here to stay inside the companies? Do you think there's gonna be major changes to the way that we do business? Or do you think we will go back to the way we're operating using some of these AI tools and having our people do the work? Do you have any thoughts on that? Yeah, so I was there during the dot-com boom, and there was a lot of magical thinking that was going on about the technology. There were two companies, I remember this distinctly, called Commerce One and Ariba, and they were going to disintermediate all brick-and-mortar companies because you wouldn't need to go to a store. You could just order everything on the internet. It was gonna be utopia. The reality was it was a lot different, but the internet was real technology, and the real true wealth that was built from the dot-com episode was built after the dot-com episode. And what I mean by that is Google IPO'd after the dot-com episode. Facebook IPO'd. Amazon really came into its own. Apple took advantage of all the cheap broadband from the infrastructure build-out, and we would not have a smartphone if we didn't have cheap broadband. So AI is a real thing. It's been way overhyped. It still has a very high hallucination rate, so it can't just take over the world because it makes too many mistakes. But after the bubble bursts, there'll be new companies. There may be some companies that are currently involved that take advantage of the technology, but it's not gonna be the frontier model because that's being commoditized away. It's what you do with the models and what services you provide on top of that. I think there's gonna be a lot of excitement after the crash. Excitement meaning a lot of great companies that we have to find as investors. Do you see similarities right now with the AI innovations and the dot-com time? It looks like some companies are behaving in a similar way. Can you tell us what you're seeing right now that compares to- Yeah, so, yeah, I was a technology analyst in 99, 2000 at a firm called Independence Investments, or actually, yeah, 99, 2000, 2001. And what we saw then was a tremendous excitement and a tremendous infrastructure build-out. And the companies that, the stocks that really benefited are very similar today. Some of the companies, more specifically NVIDIA, back then it was Cisco, Lucent, and Nortel. And they were providing routers and gear to enable the internet to work faster. And there was a, after the 1995 telecommunications act, there was deregulation. So the Bell system, the AT&Ts of the world, and the Verizons were the legacy players. They were buying infrastructure to upgrade their network. But there was a whole new slew of companies called CLEX, who, like WorldCom and Quest, and what have you, that were building infrastructure and didn't have revenues. Or if they did, they weren't making money. And they were raising capital to spend on the infrastructure. So Cisco, Nortel, and Lucent really benefited from that. As credit became tighter, Lucent and Nortel and Cisco started to offer what's called vendor financing. And Lucent's on record saying we're becoming a bank to our customers. Well, you know, let's fast forward to today. That's what NVIDIA's doing. They're lending money to their customers to buy their gear. And that's all great until the bond markets and growth slows down. The bond markets are telling you growth's gonna slow. Once the growth slows, then NVIDIA's gonna have problems because they're overextended. So it's very similar. And this time, the problem is that the numbers are much, much bigger than they were last time. Ed, you mentioned that valuations are really high compared to 2000s. But a lot of people that we've been talking to who are very bullish on AI and they see the backlogs, they think their PEs are not like they were in 2000. A lot of companies may not have high PEs. What are your thoughts on that? Well, our valuation metrics on the whole S&P 500 have never been higher. There may be individual stocks that look cheap based on forward earnings. But forward earnings, when you see multiples compressed, that's the cycle telling you they don't believe the forward earnings. We have three measures we look at. We look at Shiller, we look at the Buffett indicator, and we look at our own proprietary NASDAQ indicator. And they're all off the charts. With respect to the semiconductor stocks, they look cheap, but they always look cheap at the top of the cycle because the earnings are not, it's the cycle. Semiconductors are very cyclical. There's currently 20% of the S&P 500, which is even bigger than their weighting was at the dot-com height. So we have basically 20% of the S&P is represented by a very cyclical industry that has blooms and busts. And I would suspect if the bond market doesn't wanna finance this because the profitability is being questioned, all those orders on those backlogs will evaporate and we'll have a nice downturn in semiconductor stocks. They're off 20% from their highs. And a lot of people think that's the top. We don't know yet. Need more time to figure that out. But if it is the top, semiconductors have got, typical semiconductor cycle is a boom and bust. And sometimes they go down 50% in the dot-com bust, they went down 80% from top to bottom. So you see the backlogs not being as locked in as a lot of people. So the backlogs always look great at the top of the cycle. And if the bond markets, look, if this infrastructure build out was being financed by cash flows from these companies, I would say, hey, maybe the cycle is gonna be shallow and you wanna buy the semiconductors on a dip. But this is all being financed with debt. And the debt markets are financing this on the hope that profits and revenue show up. And now that's coming into question because of the open source competition, the fact that the ROI from the enterprise isn't there. So there's always an over expectation of growth. And I think the growth curve is slowing and rolling over. And that's why we're seeing what we're seeing this week with OpenAI and Entropic wanting to slow themselves down, quote unquote, it doesn't say. But the cycle is the cycle. There's always too much infrastructure investment that gets overbuilt. But bubbles are actually a feature of capitalism, not a bug. Bubbles long-term create a lot of difference in time. During the railroad infrastructure bubble, a lot of investors got wiped out, but we had railroads and then the economy boomed for the next several decades after the traffic delay. Same with the dot-com boom. There were a lot of companies that went bust and stocks went down 50%. But look at what's happened since the advent of the internet, things are a lot. It didn't happen as quickly as was expected. AI, same playbook. Too much enthusiasm, too much hype. And now we're starting to realize why the other infrastructure build-outs, the pipes and railroads and the frontier models were all commodities. But the real world comes after. Now, in terms of geopolitical issues, as you're having your plans for the near future, you're seeing a downturn. What do you see happening in the geopolitical side of things? The wars are inflationary. And what are your thoughts on that? Is this going to cause a change in the way you see inflation? Wars are typically inflationary, that's absolutely a fact. The problem is that this war is centered around the Strait of Hormuz and the price of oil, which is causing oil to spike, which will pull forward demand destruction and only weaken the already weakened U.S. consumer and other consumers in other countries. And demand destruction will ensue. And so we'll get a recession. But long-term, we are in an inflationary regime. This is a deflationary, disinflationary scare. Valuations of assets are too high. There'll be a correction. Then the Fed's going to do what it does and print money to bail out everything. And the government will run deficits and we'll have inflation again. So we're in this cycle of inflation, deflation scares, inflation, deflation scares, because the debt levels of the globe are just too high. And so the powers that be in the money masters have to inflate, it's inflate or die. You can't have deflations last too long. There's always a scare. There's always an overinvestment in credit. There's always a credit cycle. That's why we have these scares every decade or so. Now, do you have any recommendations for our audience who might have 401ks, who are watching the financial markets? Yeah, look, I don't like to give financial advice, but if you're heavily overinvested in the stock market, it might be prudent to raise a certain amount of cash in your portfolio. Cash is a position, it's called dry powder, and you can take advantage of lower prices. I'm not going to tell you what percentage you should raise, but it's prudent to raise cash if you're heavily invested in stocks, because mathematically speaking over the next 10 years, you're going to earn 0%. Again, that usually indicates there's a large dry down between now and then. And I think the dry down is closer than you think. Ed Dowd, it was great to have you on Market Insider. Please come back and share your insights with us in the near future. Thank you, and you can find me at edddowd beyond the narrative sub stack. Tell us what you think about the current state of the economy. Do you think things are not as good as what the markets are saying? Make sure to comment. And we'll read all of your comments. I'm Siamak, this is Market Insider. We'll see you next time.