Desperate for DOGE

The U.S. deficit just jumped 12% this fiscal year, from $1.77 trillion to $2 trillion. Remember the D.O.G.E. chainsaw? We were promised the Department of Government Efficiency would carve through waste, fraud, and abuse and eliminate our deficits and pay off the debt. Well, mission accomplished, if the mission was making them bigger. The national debt is surging, and business debt is surging right alongside it.

Of course, carrying a $40 trillion national debt (123% of GDP) and $33 trillion in non-financial business debt (73% of GDP) doesn't matter much when interest rates are near zero. That was the game for over a decade, and everybody played it. But when sovereign debt no longer yields 0%, it yields 5%; and when high-yield business debt no longer costs 4%, it costs more than 8%, that is a problem—and a rather large one. Funny how the bill always arrives eventually.

The Fed is forced to add to the pain

Fed Chairman Warsh should raise interest rates on October 28th. It really is that simple. The FOMC hiked on September 16th, when CPI was up 3.4% year over year. The latest reading is an even hotter 3.7%. If 3.4% justified a hike, then 3.7% demands one. Math isn't hard. Politics is. And if the Fed passes in October, don't let anyone tell you it was "data dependent." It will be a political decision, made so the Fed doesn't appear to be influencing the mid-term elections. Because nothing says independence like carefully scheduling inflation around the ballot box.

But even if they punt, they can't escape the arithmetic. We believe the Fed ends up raising the Fed Funds Rate a total of 75 basis points this cycle, bringing it to a range of 4.25-4.5%. By the time 2027 rolls around, consumers and businesses will have been battered by six years of inflation and sharply rising borrowing costs. Six years. Very few balance sheets were built to withstand that, least of all one levered up during the era of free money.

Earnings are next in line

Meanwhile, corporate earnings are under pressure. Companies won't enjoy another $100 billion in tariff rebates. Instead, they'll have to lap a massive $580 billion annual AI investment, roughly $300 billion of which was financed by issuing new debt. Yes, borrowed money. At today's rates. To build things that, so far, haven't earned a return. What could possibly go wrong?

A lack of ROI combined with prohibitively high interest rates should not just dampen the desire to keep spending. It should significantly reduce the amount of investment in this critical area. And that means the 33% EPS growth we witnessed this year will be nearly impossible to duplicate next year. Wall Street is pricing in perfection. What it's going to get is a sharp deceleration in earnings growth.

The canary in the coal mine

To best illustrate the point, look no further than CoreWeave. CoreWeave, Inc. is a "neocloud" company—because apparently "data center" wasn't exciting enough—that builds and rents out graphics processing units dedicated specifically to artificial intelligence. It operates 51 AI data centers designed for high-performance parallel computing through heavy use of those GPUs.

Analysts are now slashing earnings estimates for the company by 50-70%. Its bond yields have surged into the 14-15% range, which tells us the market is growing very concerned about its creditworthiness and its ability to service its debt. And what a debt it is. CoreWeave carries over $35 billion in borrowings, and $52 billion once you add in lease liabilities. The company is projected to lose $2.1 billion this year alone. Nothing says "future of technology" like paying 15% to lose money.

In other words, this company is in trouble.

So, is CoreWeave idiosyncratic or systemic? We believe it's most likely the canary in the coal mine for the AI investment bubble. When a company at the very center of the boom can't borrow at anything close to a reasonable rate, the rest of the field should take notice. The canary is coughing. Wall Street is telling everyone the air is fine.

The first half of 2027

Here is the situation we expect in the first half of 2027. The Fed will have consummated a rate-hiking campaign of between 75 and 100 basis points. That will occur at about the same time inflation and the economy stall, due in large part to the bursting of the AI investment bubble.

Think about what that bubble has been responsible for: 50% of GDP growth, 80% of earnings growth, and just about 100% of the wealth effect. That isn't diversification, folks. That's a single point of failure with a ticker symbol. Remove it, and ask yourself who is left to carry the consumer, the stock market, and the economy.

Don't count on Washington to ride to the rescue, either. With a $2 trillion deficit already on the books and interest costs climbing every month, there's no room left for another stimulus bazooka. The fiscal cavalry has no horses.

So where is the DOGE? Last seen leaving the building, chainsaw presumably still in the garage; out of gas and leaking oil. Nevertheless, interest rates are rising, earnings growth is slowing, and the triumvirate of stocks, bonds, and real estate bubbles have sprung a leak.

The government can’t reduce spending. The Fed can't lower interest rates. And the AI trade can't keep borrowing its way to unprofitable growth. That is a recipe for chaos not prosperity. Passive investment management has become a prescription for penury.