We've been excited about the economy all year due to fiscal, monetary, and financial conditions support, plus AI optimism. The biggest tweak in our spreadsheet is inflation, coming from war and energy prices, combined with the Fed getting more optimistic about the labor market, making us rethink how long the Fed will stay on hold. It's starting to look like they're more open-minded to the possibility they might have to hike.

There are two ways the Fed could end up hiking. One is 'good news hikes': the Fed cut rates last year as insurance against tariffs causing a recession, but that hasn't happened, so they might take those cuts back, like in 1999 after LTCM. The second is a negative story: inflation is getting stuck in the economy, becoming a problem, and the Fed needs to hike to make monetary policy tight so the economy slows and inflation comes down. Both are in the conversation.

Inflation has been too high for coming up on six years and could continue if nothing changes. Oil prices will seep into inflation and other series as well.

It's hard to not like the consumer given how much stimulus is going. Wealth effects, optimism about the future, and a resilient labor market are driving things. Consumers tell you they're unhappy about inflation but feel okay otherwise.

AI comes in two phases. The initial phase is about expectations: people look ahead, see future gains, feel wealthier and more optimistic, so consumer spend and business investment increase. Right now we're in a demand-fueled part of the AI boom, with a heating labor market. There will be disinflation later once businesses figure out how to use AI and scale it, but that might take time. For now, this means strong growth, a strong labor market, and perky inflation.

AI CapEx is really strong and will grow year-on-year this year. CapEx outside of AI has been pretty flat. The economy is transferring its investment budget away from other things towards AI. The optimism around AI is lifting all boats; without it, we'd be talking more about tariff uncertainty. It's becoming a very AI-centric economy, similar to the internet in the 90s, electrification in the 20s, or railroads in the 1800s. There are risks if the story of optimism fades—if markets sell off, we'd look for the Fed to come in with help.