Markets, Machines and the Middle East

Nick Ryder: Thank you, Vinnie.

Vincent O’Neill: Today, Nick and I will be discussing the US Fed rate decision and where to from here, oil prices continuing to spike as the Houthis escalate their activities in the Middle East, and AI safety warnings.

Nick gives his verdict on how long humanity has left.

Welcome to all our listeners.

So, “Inflation is too high and has been for too long.” That is from Fed Chair Kevin Warsh, no longer so wishy-washy this week with the US Fed’s rate decision. What’s your take?

Nick Ryder: Yeah. I mean, I think he spoke at the Jackson Hole Symposium in August and delivered quite a hawkish speech.

Vincent O’Neill: Mm.

Nick Ryder: And so…

Vincent O’Neill: Managed expectations.

Nick Ryder: Yeah, managed expectations. Then, last Friday night, we got the August CPI figures that showed core inflation was running just under 0.3% for the month of August.

Vincent O’Neill: Mm-hmm.

Nick Ryder: Which, if you annualise that, is 3.6%, well above the 2% to 2-and-a-bit percent bracket that it needs to be.

So that really put the nail in the coffin for a hike, and the market was pretty much 90% priced going into the meeting.

The key takeaways were interesting. He used the expression “removing a dose of accommodation”. The takeaway from that is that interest rates where they were were not restrictive.

And he spoke a little bit about that at the press conference. He said there’s limited evidence that policy is restrictive. He talked about stronger growth in the economy, the labour market being in good balance, sticky inflation, and discussed that when you look at the inflation basket and the things that go into that, there are quite a lot of things annualising above 3%.

Vincent O’Neill: Mm-hmm.

Nick Ryder: So he mentioned that.

Vincent O’Neill: They’ve got an inflation problem and they’re realising it.

Nick Ryder: Yeah.

Vincent O’Neill: Basically. And rates where they were were certainly not restrictive, and they weren’t going to bring that inflation problem under control.

Nick Ryder: That’s it.

I think he also spoke about domestic spending being resilient, or rather the FOMC statement said this, robust capital investment and strong productivity growth.

Really, the hike is to support a timelier return to the 2% target.

I think the other takeaway is they’re really not willing to look through these little temporary supply shocks like tariffs and the war in the Middle East, because these are continuously compounding and they’re not necessarily temporary.

Vincent O’Neill: And they work their way into the system and become…

Nick Ryder: More persistent as well.

It’s a throwback to 2022, when Powell said inflation was transitory and then suddenly realised, “No, no, we’d better act.”

Vincent O’Neill: We’ve got to fight it.

Nick Ryder: We’ve got to fight it, because you do get second-round effects that can start to impact other inflation areas in the economy.

Vincent O’Neill: You touched on something there. It was not restrictive. We have to try and get inflation back.

We’ve made this move, but I guess the bigger question is the direction of travel, and more importantly, how much they may need to raise rates to get them into restrictive settings and eventually back to where they want inflation to be.

Nick Ryder: Yeah. I think what a lot of people are saying is they’re probably going to unwind the three rate cuts we had last year.

Vincent O’Neill: Right.

Nick Ryder: So kind of take it back.

Vincent O’Neill: Do an Australia.

Nick Ryder: Do what we’re doing in Australia, essentially.

We had those three rate cuts last year. They were based on the view that inflation was going to come down and the labour market was softening.

When you look at the economy now, it doesn’t really look like the economy needed those three rate cuts.

So I think that’s kind of where market pricing is. We have a 50% chance for a follow-up hike in October, but certainly a 90% chance by the end of the year, and then potentially another one and maybe another half after that in the middle of next year.

So it’s still very much data dependent.

Warsh was asked about data points. He said, “You’ve got to look at the trend.”

It’s not a single thing, it’s a trend.

The market liked it because it stamped the independence of the Fed.

Vincent O’Neill: Harder to call into question now.

Nick Ryder: Harder to call into question.

Vincent O’Neill: They’ve gone against Trump’s politicking as much as they could.

Nick Ryder: Yeah. Interestingly, Trump did say he had a discussion with Kevin Warsh beforehand, so it’s not clear whether Kevin rang him and said, “Look, I’m going to have to lift rates.”

Vincent O’Neill: Heads up here, Mr President.

Nick Ryder: Heads up.

Donald Trump is reported to have said, “I talked to Kevin. I said, ‘You might as well vote with the board because it’s not going to matter.'”

So maybe Kevin was saying, “Well, I’m not necessarily in favour of a rate hike, but everyone else on the board…”

Vincent O’Neill: That is a bit wishy-washy, though.

Nick Ryder: Is going to vote for it, so I’ve got to go along with it because we want to have a unanimous decision.

It would look very weird for the chairman.

Vincent O’Neill: And it was a clear-cut decision, let’s be honest.

The markets and everyone had really been guided to have their expectations set that way.

Again, we’d been expecting this, so I don’t assume that changes your views of the world particularly. Is there anything in it that might?

Nick Ryder: Not really.

We did get some new dot-plot projections. Not that you necessarily place a lot of value on those, but certainly most people on the Fed are seeing another rate hike by the end of the year.

So 4.125 is the median dot for the end of the year, which implies another rate rise this side of Christmas.

They’ve also taken out a lot of the rate cuts that were in the prior dots for next year and lifted the long-term rate, or neutral rate.

They’ve also lifted growth expectations and near-term inflation forecasts.

So it’s fairly positive from a growth, inflation and employment perspective, and that plays into why they need higher rates.

Vincent O’Neill: Higher interest rates. That probably plays back to one of the points we discussed on the last podcast, which was that interest rates are really just moving back into the sort of territory they were in 20-ish years ago and back to normality.

Nick Ryder: That’s right.

He was asked at the press conference why bond yields had gone up and talked about economic strength, competition for capital from AI, who are obviously issuing a lot of bonds to fund data centres, and geopolitical risks, including energy.

Vincent O’Neill: No commentary on the deficit?

Nick Ryder: Exactly. No commentary on the deficit.

Vincent O’Neill: Maybe that was what they discussed on the phone call.

Nick Ryder: That’s important because you might recall he said he was looking to the market to provide guidance for what the Fed should be doing.

So it was interesting that he was saying that about the rise in bond yields.

I think that’s, in some ways, similar to what’s going on in Australia, where we’re looking to remove the prior rate cuts with a view to bringing inflation back to target more quickly.

It’s a very similar story in Australia.

Vincent O’Neill: Makes a lot of sense.

One thing we touched on last week, on an inflationary theme, was continuing events in the Middle East, the spread and escalation of activity by the Houthis in particular.

Oil has been bumping around and certainly in triple-digit territory in recent days.

What’s the latest?

Nick Ryder: There has been an escalation.

We’ve seen the Houthis really take control of a lot of the Red Sea, particularly around the Bab el-Mandeb Strait, and try to choke off a lot of the Saudi ships sailing through there.

The Saudis have this east-west pipeline that goes to the Yanbu Port, and they were loading a lot of their oil through that and sending it out through the Red Sea to Asia.

Now that’s looking more problematic.

For a start, we had a drone attack on a pumping station, and that was one of the reasons the oil price went up to about $108 or $109 a barrel, with people thinking it would be out for a while.

In recent days they’ve said they’ll probably be able to bring that back online more quickly, but there’s still the issue of getting Saudi ships through the Red Sea.

They may have to go through the Suez Canal and then all the way around Africa, which adds several weeks.

Vincent O’Neill: As you touched on when we last spoke, this is really about leverage in current negotiations.

Oil at these prices is certainly not sustainable for a healthy economic outlook.

Nick Ryder: Interestingly, there is a report in the press saying the Saudis have asked the Chinese to ask the Iranians to tell the Houthis to back off.

Vincent O’Neill: Right.

Nick Ryder: Because China is a massive importer of Saudi oil, and to some extent Iranian oil.

The Chinese had done very well in the sense that they had been able to curb their imports and run down some inventory.

But there’s a feeling that swing factor is now going the other way, and they may need to re-import a lot of oil from the Middle East.

Maybe the Chinese are becoming more concerned with some of the developments.

Vincent O’Neill: The instability in the whole situation.

Nick Ryder: Yeah.

There’s really a feeling amongst global oil analysts that we’re reaching an inflection point where, if some of these flows don’t restart, we could see oil prices, and particularly diesel prices, go up quite a lot.

They’re already over $6 a gallon in the US.

There’s now talk that the US could potentially ban exports of diesel.

Vincent O’Neill: Right.

Nick Ryder: Which would be to preserve it for their own farmers, truckers and so on.

That could actually be quite destabilising.

Vincent O’Neill: Yeah, there’s definitely concern regarding diesel.

The US, for example, picked up the phone to Zelenskyy and said, “Attack Russia if you must, pick strategic assets, but please avoid any of the diesel infrastructure.”

It’s clearly a sensitive point.

Nick Ryder: Yeah. But there are others in the US administration saying, “Well, if you ban diesel exports, a lot of these refineries will just stop producing it.”

Because they don’t want to sell it at a lower price.

Vincent O’Neill: To the domestic market at a lower price, potentially beneath cost.

Nick Ryder: Exactly.

So interfering in these markets can actually be quite problematic.

Vincent O’Neill: The bigger-picture challenge is that the longer this continues, the more supplies get depleted and the greater the danger of long-term negative impacts on growth.

Nick Ryder: Absolutely.

We’ve been able to muddle through reasonably well.

Apparently there was quite a lot of oil getting out through the Strait of Hormuz at midnight under US naval escorts and things like that.

As I mentioned, some through the Red Sea.

But to the extent that this becomes more problematic, it could become a real oil shock.

Vincent O’Neill: A real lingering issue.

Now, the world has largely managed to cope with this situation or find other positives.

The big positive this year has been AI. AI development, AI infrastructure, all the spending around that and the economic growth it’s driving to help offset concerns around what’s happening in the Middle East.

AI has been in the headlines for different reasons in recent days, with people speaking out to raise concerns about…

Nick Ryder: The end of humanity.

Vincent O’Neill: The end of humanity.

Nick Ryder: We’ve had all those press reports of cutting-edge models at OpenAI and Anthropic escaping sandboxes, hacking other systems and companies.

In fact, there have been more reports from OpenAI in recent days that this has happened, including six previously unreported incidents.

Then we’ve had researcher Jacob Coxon, who quit Anthropic.

Vincent O’Neill: After several months of working there.

Nick Ryder: Yeah, he wasn’t there very long. He previously worked at OpenAI.

He’s saying there are safety problems.

Then another safety researcher at Anthropic said he put the chances of human destruction at 10% in the next decade.

Vincent O’Neill: Before the end of this decade, I think he says.

Nick Ryder: Right. So that’s not far off.

We’ve also had Anthropic CEO Dario Amodei write a 4,000-word paper calling for greater regulation, which Sam Altman from OpenAI and Elon Musk from Grok have supported.

Then there’s a whole lot of debate as to whether this is regulatory capture.

Vincent O’Neill: Creating an economic moat.

Nick Ryder: Creating a moat for themselves, particularly as they look to IPO at $2 trillion valuations.

People are scratching their heads and saying, “Is this also a way for them to avoid product liability?”

If you’re developing a product that’s not safe…

Vincent O’Neill: And you tell everybody how unsafe it is.

Nick Ryder: Exactly.

And if regulation doesn’t happen, are you trying to avoid responsibility for what your products might do?

Or is it also an effort to reduce this cut-throat competition where everyone has to continually build and train better models because their competitors have done so?

Vincent O’Neill: It’s an AI arms race.

Nick Ryder: Huge amounts of money are being spent on this AI arms race.

Amodei was talking about slowing the arms race to allow time for more safety inspections and things like that.

Vincent O’Neill: There are a lot of existential questions there that we’re not going to answer on this podcast.

I guess the more immediate question is whether regulation starts to creep in. What does that mean for the current trajectory of spending, building and investing, and potentially for some of these IPOs we’re on the cusp of seeing?

Nick Ryder: Some of these questions are interesting.

It’s probably not possible to make these systems completely safe because they’ll find ways around the guardrails.

Vincent O’Neill: Kill switches.

Nick Ryder: To some extent, yes.

I recently saw a research report saying they had a whole bunch of AI agents that actually started inventing their own language to talk to each other.

Humans weren’t able to work out what they were saying.

It’s a whole new world.

Then there are new drones being used in Ukraine and Russia with AI-enabled controls that almost make targeting decisions themselves.

I think there definitely needs to be some discussion.

Vincent O’Neill: There’s scope for some controls.

Nick Ryder: Around this.

But how much of this is OpenAI trying to serve its shareholders versus serving the public at large? That’s an open question.

Certainly the Trump administration seems reluctant to impose regulation or slow down competition with China at the moment.

Potentially it’s something that could be discussed at the upcoming meeting with President Xi on 24 September.

Vincent O’Neill: Yeah.

Nick Ryder: So let’s watch this space.

Vincent O’Neill: There’s a very wide range of possible outcomes we’re dealing with here.

It’s a hot topic and it’s become a very political topic in the US, so it’s going to continue to attract a lot of attention.

Nick Ryder: You had Bernie Sanders and Steve Bannon…

Vincent O’Neill: On a platform together.

Nick Ryder: On a platform together, both arguing for…

Vincent O’Neill: Hard right and hard left.

Nick Ryder: Clamping down on AI.

So it’s pretty interesting.

Vincent O’Neill: Just bringing them together demonstrates how interesting the issue has become.

Last one, but quickly. News over the last 24 hours that Canada, which has obviously been having an ongoing trade dispute with the US, is now cosying up to the EU and exploring the creation of a new, as yet undefined, associate membership category.

Any thoughts around that?

Nick Ryder: I think it plays into Mark Carney’s speech at Davos earlier in the year, where he argued that middle powers and medium-sized countries like Canada and Australia need to band together and potentially look at other alliances.

To the extent they can’t count on the US anymore, it makes sense to partner more closely with the EU.

The thing is, they already have a free trade agreement with the EU, so it’s not clear what extra benefit they would get from associate membership.

I can’t see them being willing to fall into line with Brussels laws or free movement of people.

But it’s something to keep an eye on.

They’ve also suggested that countries like Australia and others could potentially qualify for this associate membership.

So it plays into this broader reorganisation of alliances and global trade.

Vincent O’Neill: I think you articulated it well.

Mark Carney spoke excellently at Davos and really called out this changing world order.

He led that charge and articulated it well.

This may be symbolic, but it’s a way of saying to the US, “Yes, we’re dependent on you, particularly in Canada’s case, but we have other options too.”

That’s probably a healthy thing.

Nick Ryder: Yeah. Although Trump has threatened Europe.

Vincent O’Neill: Shock horror. Trump threat.

Nick Ryder: So we’ll just have to see how it evolves.

But I think it’s just the world we live in.

Vincent O’Neill: A rapidly evolving landscape.

Nick Ryder: Yeah.

Vincent O’Neill: Wonderful, as always, Nick. Thank you very much, and thank you to all our listeners.