Ten31 Timestamp: Partly Cloudy

0:00 Monday, October 19th, year of our Lord, 2026. John Arnold, we meet here to go over the situation that was monitored over the weekend. How are you, sir? I'm really disappointed because I was promised Black Monday. If you were on the timeline over the weekend, if you happen to be an ex-addict, as I imagine most of our listeners are, unfortunately, you were probably shown charts on Saturday night showing that there was a massive 50 basis points wick on the S&P on Hyperliquid, And that was supposed to be presaging Black Monday this morning.

0:32 But thus far, I'm seeing much less chaos and carnage than I was promised. So unfortunately, nothing can induce ever happen. Quite the opposite. NASDAQ up 1.4%. S&P up 67 bips on the day. Dow Jones positive as well. VIX down. Yeah. No Black Monday here. I am not, in fact, entertained. Neither. We won't talk about the French riots.

1:04 We're going to jump straight into something we discussed last week, which was the, it wasn't Anthropic specifically. It was talking about OpenAI and the revenue numbers. I remember that was two weeks ago, but big headlines here over the last week from Anthropic. Anthropic third quarter revenue is set to hit $16.8 billion ahead of IPO.

1:24 Big number, but growing slower than previous quarters, and that's causing a lot of consternation. A lot of people are saying the AI trade is over last week over the fact that a lot of the neoclouds tanked, and then we just have Anthropoc coming out and saying they're going to strengthen their defense against distillation.

1:43 Attacks in recent months, we've made substantial progress in reducing the effectiveness of distillation attacks on Claude using new methods that we outlined in this blog. Only evidence suggests that these methods have reduced the amount of data harvested by distillers by around 90 to 99 percent. So trying to protect what they deem to be their IP.

2:02 But I think the all-in guys were talking about this over the weekend too. The whole business is built on a massive distillation attack of all the information that has ever been aggregated in human history. It is a bit ironic when you kind of step back and think about it. But, you know, I think like the, this is, I felt like a good lead off for the week because this is where, you know, this whole story, the AI complex is really where a lot of the themes that we talk about kind of meet most keenly.

2:30 Everything from, you know, real resource demand to running it hot, to reshoring, to geopolitical competition, ultimately to, you know, the government's ability to fund itself. And then through that to Bitcoin. So all roads kind of run through this right now. And you can see that in markets last week.

2:45 Um, yeah, as you said, this, the, the, um, testing the waters meeting or maybe just be, uh, maybe post testing the waters now, it may just be the actual roadshow. But in any case, the private investor meetings that Anthropic did last week failed to fail to impress. Uh, there was deceleration in Q3, which is the literal, uh, you know, worst, worst thing you can imagine as a, as a public markets investor, especially if you work at a massive platform shop, the one thing you can't do is decel.

3:10 And there was deceleration, even though we're at, you know, numbers that a year ago probably would have been, you know, gotten you laughed out of a lot of rooms, at least on the East coast. And I just thought that, you know, the, I think there was a lot you can say about it. There are a lot of projections you could make.

3:24 The distillation piece was interesting to me because, you know, I think there's some debate over how much impact that might've had on Q3 if they were kind of aggressively moving to, to reduce, you know, distillation. And now you kind of pass that headwind and maybe you see growth pick back up. You could also make the argument that, well, if a huge, if a meaningful amount of the business was built on distillation that they're not going to allow, then how much revenue growth was somewhat unsustainable. So, I mean, people can make their assessments on that. But either way, I do think you're getting into a point now of the numbers have gotten big enough that it's going to get harder and harder to sustain the level of optimism and constant bid and

4:04 constant positivity around the story. If you're seeing any hint of things kind of slowing, I think the distillation element is interesting on a geopolitical perspective because, you know, on one hand, I can agree with all the all-in guys that, well, it's kind of like, it's kind of unfair. It's kind of ridiculous to be against distillation when, you know, all the IP was in some sense built on distillation.

4:23 The flip side is, you know, I think we're going to see if it has a meaningful impact on kind of the delta between the frontier and open source, you know, and open weights. Well, that probably won't be answered until, you know, the next few months or through the end of the year as we see model releases and how they stack up.

4:38 But from a national security perspective, from a winning the AI or the SI race, I guess, perspective, I do think that it'll be very interesting to see how much that actually matters to kind of the open model competition. So everything right now, everything is AI. Everyone's an AI investor in one way or another, and everything kind of runs through this.

4:57 And you flipped over to this next slide. You can kind of see that in the, let's say the cuspier parts of the market, the companies that are most levered to this trade and especially kind of on the riskier end or what perceived to be the riskier end So left side we got charts of the equity of a few of the big neoclouds I think some of them would object to that label, so they can forgive me, but the inference providers that have sprung up to fill the insatiable inference demands, taking a massive hit over the last week or two, largely, I think, in the last week on the growing consternation around Anthropic ARR, OpenAI's ARR. And you've seen that as well in some extent. Credit default swaps kind of blowing out for CoreWeave and some of the other players. I think it's a little,

5:44 I'm always a little wary of reading too much into credit default swap markets on a short-term basis, especially for kind of either smaller players or players that only just now recently got kind of CDS data that was being quoted. But nevertheless, it's clear there's, if you're looking at anything at all. Like it's clear there's growing concern about the sustainability of the build out and the economics of the labs. And then also the companies that are kind of rising up to fill inference demand. Um, and I think, you know, you're increasingly seeing one camp saying the demand for, for intelligence is effectively infinite. And so kind of none of this matters in a short term noise and another camp saying, well, that, that may be the case, but in the interim, uh,

6:24 we, we have to find ways to actually find the Marshall, the real resources and the physical world atoms and the financing capacity to fill that demand for allegedly infinite intelligence. And you're seeing last week, you really saw those two things kind of run into a wall in a real way. Yeah. And a lot of additional concern in these markets, really for CDSs and all the credit going into the space is interest rates. What's going on with the rates? Are they going to say hi forever?

6:52 What is the cost of capital for this build out, particularly for the non-IG rated players? And this is where we shift to the Fed and the conversations they're having around inflation. Inflation came in a bit hotter than expected for some sectors of the economy. Last week, obviously, the wars in Iran and between Russia and Ukraine are driving up oil prices, which is the input of the economy around the world.

7:22 So it's having an effect on inflation. I think that's sort of parallel conversation going on with the build out of the AI infrastructure is what is the cost of capital for all these players going to be? And I guess that's where the Fed and the Treasury come in. And we have some headlines here, different comments from different Fed governors on inflation and how they're going to manage it moving forward.

7:45 Yeah, it was really interesting to see last week when you had a lot of this consternation that we talked about really hitting a fever pitch and long-end rates getting as high as for the 10-year back over 5.3% briefly before, interestingly, a sharp intraday reversal back down to almost 5% even after hotter than expected inflation prints.

8:08 So that's that's the market telling you something interesting, I think. But I thought even beyond that, the more notable thing was you've got this or at least at least as notable as you've got all of this this worry and, you know, Black Monday's coming kind of concern over the week. And against that backdrop, you've got all all of the unanimous kind of talk track of the Fed officials that decided to to talk last week, which this is an interesting way to not do forward guidance anymore, to be constantly talking about, you know, inflation expectations and the path of rates.

8:35 But, you know, maybe maybe Kevin Warsh is still kind of working on the getting everyone in line. But in any case, all three of the, you know, the major Fed officials who spoke last week were basically telling you, well, actually, despite the hotter inflation prints you're seeing, expectations are well anchored.

8:50 We don't necessarily need to do much more on rates or at the very least, we don't have to be super urgent about it, even though inflation is not where we want. And the inflation that we're seeing is either related to kind of the short term geopolitical events and headwinds or it's related to or and additionally, the growth, the rate path that we've seen in the last year or so.

9:09 A lot of that is related to growth and capital competition. That's one of the things that Waller said in his comments. And so, yeah, very, I thought, noteworthy kind of lack of divergence on the rate path and the way that we should be thinking about inflation and its impact on rates and what the Fed's going to do.

9:25 in a market environment where, as you said, everyone was going back to their models and trying to re-underwrite all this math against the backdrop of like kind of durably, durably higher rates. So, you know, I think that there's still a lot of, for all the talk of, you know, moving away from forward guidance, there's still a lot of, you know, pro market kind of jawboning going on as things start to get, you know, a little hairier, which I think tells you something.

9:49 Yeah. And you put this slide up here, which basically tries to articulate the feedback loop that we're seeing with rates, with inflation rates and their effects on the cost of capital for this build out and how that in turn affects how you hedge in this environment. Yeah, this is a, I didn't actually get this into the timestamp this week. I saw the article going around on Twitter over the course of the week and I just forgot to get it down in my notes.

10:18 But this is from I wanted to put this in here because we talked a lot at length over the past year or so about the move index So the treasury volatility index and this uh the stuff on the left comes from these are screenshots from a post by Harley Bassman on his blog at convexity maven and bass bassman is the one who originated the move index. And so, you know, I thought it was the, he's kind of the godfather of the, you know, the deep study of bond volatility. I thought it was that we've been talking about. I thought it was important to kind of have this in there. Um, it's definitely, it's a read. It's like six or seven pages. I think it's, it's reasonably accessible, although technical.

10:51 It's something that, you know, it's beyond my, my major wheelhouse. It's as not a, not a credit guy, but I think it's worth going through. And there are a few kind of big things to point out here. And I think basically he's making the argument that we are kind of approaching a potential kind of event horizon in terms of negative bond convexity and bond volatility, where we've had Since 2007, since great financial crisis, we've had a rate environment where essentially we've been well below 5%.

11:20 And as a result, the effectively, and this gets like very kind of jargony and inside baseball, but the generic bond that has gone into bond futures contracts has had a duration of roughly 11 for the cheapest to deliver bond that flows into those contracts. And duration is a bond prices sensitivity to changes in interest rates.

11:40 And what he's arguing is that as we've drifted much higher in recent months, not just drifted, actually ripped much higher, we're kind of getting to a point where increasingly you're getting close to the cheapest to deliver bond being one of longer duration. So having moving from that 11 number that you see in green to potentially something more like 17 and a half down in red for various kind of mechanical reasons.

12:03 And so as a result, the thing that he's highlighting here, the cycle that he's highlighting is if the cheapest deliver contract starts shifting longer duration, then you end up with the trades being made with portfolio managers looking at their their exposure and their allocations. And they will increasingly have more duration exposure than they want to have from a portfolio management and kind of risk management perspective.

12:24 So they will, in some cases, mechanically have to sell duration to manage that. That obviously has a negative feedback loop impact then on yields and the price of bonds. And so you could get into at higher and higher levels. And I think he calls out kind of 6% as the real nightmare scenario for the 20-year.

12:41 You could get into this really negative feedback loop that then has the basis trade will also potentially start to unwind with treasuries. And then that adds more fuel to the fire. So specifically, he's calling out the 20-year here, which I think is interesting. Because as we talked about last week, Besant had allegedly, I think, I don't know if he's confirmed this, but the Citigroup had a note out saying that Besant would maybe cut or even just eliminate 20-year issuance altogether.

13:07 And we're now up here at five and a half, and we were at as high as like five, six, five, seven a week or two ago. And so it's interesting data point, interesting timing as it relates to kind of that rumor floating around. I think it's like, from what I understand, from what I gather, kind of reading it, also listening to Matt Dines, as everyone should, on Mindprint Hash, kind of looking through this over the past weekend, this is not an insurmountable problem.

13:35 It's ultimately kind of a mechanical problem that the Treasury can, you know, has tools to deal with. But I think it's another iteration of the theme that we've talked about that you've got to be able to kind of fix the plane while it's flying. And what are the like little fixes and things on the margin you have to change to avoid like the sudden nonlinear blow up of the whole system while you're trying to kind of re-architect it.

13:59 And I think this is a big one to watch. And I, you know, I guarantee you that this is not listening to this episode is not the first time that Scott Besson has heard this argument, nor, you know, it probably also wasn't, you know, reading the Besson paper. I believe it's probably well understood within the Treasury.

14:15 But worth worth watching and thinking about that, again, this is like of the theme where this is this is like long term. The absolute level of rates matters long term. The interest burden on on the federal government matters. Absolutely. And I think it has ultimately one kind of pathway to. to resolve. But in the short term, I think it's a lot more interesting and important to focus on kind of these like plumbing issues that can pop up and need to be managed. So I think this is a good place for people to focus. Yeah, it is a rock and a hard place because if Scott Bessent and the Treasury come out and say, hey, we're aware of the situation, here's how we're going to manage it. That sends a signal to the market like, oh, they're doing some emergency facility

14:56 or something like that. Like something must be wrong. So definitely we'll be watching this and we'll be monitoring the situation. I think it's a fight club situation, right? Where the first, the first rule of any of this is you don't talk about any of it publicly, or you do it like very indirectly, maybe, and you do it through press releases or you do it through, you know, changes in, you know, buyback plans or whatever. But yeah, I don't, I don't necessarily expect that we're going to, anyone's going to come out and cite all this kind of directly from, from treasury.

15:24 You're not going to see Scott Besson come out and say the 20 years approaching the Carnelian and Jasper lines and we need to fix this before it hits the event horizon It the Jasper lines that got him He saw that and he was just like yeah we gotta do something Moving on I mean we mentioned it earlier I think one of the thorns in the side of this administration is the wars that are driving up oil prices, particularly for diesel, which is extremely important for global supply chains and getting end goods to consumers at the end of the day.

15:58 And it looks like the uncertainty around these markets is only increasing. Well, maybe the first headline is a bit of certainty about what the price is going to do. Next year, we see diesel squeeze set to last well into 2027 as a round war disrupt supply. The IEA says there's been attacks on Riyadh's airport, which killed 12 and wounded more than 300.

16:20 We discussed that briefly last week. And then you have Yemen's Houthis are going to continue to attack. The uncertainty around the oil and gas supply chains in the Middle East is, at the very least, where it was last week and in previous months and arguably higher right now. And so I think this is definitely top of mind for the Trump administration.

16:43 In fact, I'm not sure if you saw it, but President Trump sent out a true social post this morning trying to drive the narrative that he's working very hard on a peace deal between Russia and Ukraine specifically. Yeah, I skipped over the Russia stuff this week just for time, but no doubt an interesting shift in the interesting way to apply the the Lindsey O. Graham sanctioning Russia Act in two weeks after it was passed.

17:09 But I think it's all tied up with this slide or a lot of it is tied up with what you're seeing on the slide. The left side of the chart is or the left side of the page is obviously like the diesel situation remains remains tough, even as flows pick back up in Hormuz. And, you know, it's, you know, we're, I think, probably going to see more headwinds rather than less, or at least the same amount in the very short term when you look at attacks kind of ramping up, you know, sadly around the Gulf and even going so far as, you know, a direct attack on the headquarters of Aramco in Saudi Arabia.

17:37 But I think what's interesting, too, is that on the right side is what you have. What you have there is a chart that's trying to plot demand for oil products, gasoline, distillate, jet fuel, other oil in the U.S. over the last five years. And it's the one you want to focus on is the solid yellow line.

17:57 That's actually at a five-year high is what that's telling you. So despite all of this, despite much higher prices, all the disruption, you're in a place where you have not yet seen if, you know, this is one data point. But this, I think, generally is affirmed by others. Like you're not really seeing demand destruction yet in the U.S.

18:12 And so I guess we've talked about I'm not really sure that you can afford to have demand destruction to keep the whole train spinning. But, you know, you look at that chart on the right, I think, tells you like why, you know, the Russia deal is becoming more of a focus and getting peace in Ukraine and getting refineries back online in that region.

18:31 And we don't have it on here, but there was another kind of a PR this week from Prime Minister Carney in Canada saying that he's, you know, happy to continue to maximize production and shipments of diesel to the U.S. And so, again, it's just like managing all these little fires at the same time, keeping as much of a lid as you can on diesel prices while not having that yellow line, you know, suddenly gap like way below all of its counterparts on the right side.

18:56 And, you know, I think it's we can we'll see in some other slides here, maybe there's a reason to think it, you know, there's still a lot of cards to play and it can work out. But this is no doubt the a good illustration, I think, of the real resource constraints that that we're running into here as we try to manage the combination of the first major industrial growth impulse that the U.S. has seen in like, you know, 20 plus years with an historic disruption to global energy infrastructure.

19:21 Yeah. And I mean, that gets to the next slide, which is our boy Javier Blas shifting attention to Iran specifically and highlighting their GDP projections for this year. And it's like we're approaching negative 10% GDP growth within Iran, which would be the lowest since 1985. And so the blockade and the attempt to squeeze Iran to the negotiating table by making their economy, putting their economy in dire straits and sort of forcing the issue.

19:57 And so I think that's what Javier is saying here is the chart of the day, which is Iranian GDP growth. And so is this enough of an economic contraction to – is the stress enough to get them to the negotiation table to stop and to draw less of a hard line and make some concessions on the Iranian side of things?

20:19 Yeah. I mean, we'll see. But it certainly – I think it encapsulates nicely in just one chart the headlines we've been talking about over the last – especially month where you're starting to see even kind of mainstream outlets like The New York Times acknowledge their kind of meaningful economic disruptions in Iran.

20:33 that are causing significant problems for the IRGC. And I think it remains kind of a push and pull and tough to make an exact call. But I think every time I look at a slide like the last one where I see, okay, we've got these diesel disruption issues, we've got widening attacks, against, you know, still we haven't had to demand destruction in the U.S.

20:53 Those are headwinds. That's, you know, a problem. I also look at, you know, a chart like that from Javier, and I say, like, that's kind of the dynamic you're looking at with this game of chicken, right? It's always important to kind of keep that in mind with these stories. Yeah, and then shifting to the other superpower in the world, China, and what's going on there.

21:12 It seems like they're benefiting massively right now with everything going on in AI and disruptions in the global economy in other parts of the world. So it looks like they're propping up stocks with buybacks, Xi's superpower ambitions, fuel, dangerous debt spiral in China. But then China's exports surged by 36% in September, riding a wave of tech demand.

21:35 Yeah, so I think this whole page, this whole discussion is a bit of a Rorschach test. And I've seen people comment that these MAGA slot bros, which I resent that, but if these MAGA slot bros only read American sources, and that's why they think what they do. I'll have you all know the top left-hand headline is from the South China Morning Post. So let it be known that we look beyond our shores. But in any case, I think I saw this headline hit, and there was some victory lapping from different individuals that, oh, well, so much for Liberation Day, so much for what Trump's trying to do with trade, China's still ripping exports. But I think if you look at, There's the chart below that, the various charts below that from Robin Brooks, and he

22:17 has a million more like this on a sub stack you can go look at, but basically showing like there's been disruption to US exports from China to the US. And it kind of back near Liberation Day levels but still like clearly way off long trend But you seen like ripping in basically every other market in the world And we talked about you know it ripped in the EU and what kind of impact that had on, you know, what EU governments are going to do to China.

22:40 And I think if you go and look at like someone like Michael Pettis, who's a great China analyst, has been for a while, you know, his argument is and would be, and I think quite logically is like the whole model is just based on industrial production and aggressive exports. And so if the U.S. is not going to be available as a market, you know, aggressively try to find offtake valves for production elsewhere.

23:01 And you see that across even all these smaller markets, the EU, their emerging economies that Robin Brooks points to in this data. So I think like you see this export surge and it's very easy to say, oh, well, like more exports good. That must mean things are going great. But I think there's there's more nuance to it, suggesting that this is I think this is exactly what the, you know, the plan with something that Liberation Day has been, which is to basically force, you know, dumping in a bunch of other markets and lead to a lot of kind of local displeasure with the Chinese trade relationship. And it's interesting, too, that that's happening at the same time as there's been an increase in debt to fund a lot of this industrial expansion that this Wall Street

23:42 Journal article talks about. And that's been against the backdrop of, as this bottom right hand chart shows more industrial firms now are losing money than five years ago. Right. So you're ramping up debt, you're ramping up production against the backdrop of unit economics, like meaningfully degrading. And, you know, I think that goes to Pettis's point that this is fundamentally like not a sustainable model and it requires a lot of it requires, you know, an unsustainable kind of debt burden to be built up and you know propping up the stock market et cetera to kind of keep this running And so you know this can as we we seen in the US things like this can go on for a long time And so it not a call that China collapses tomorrow or anything

24:20 But I actually think the export headline is interesting because a lot of people read it kind of the positive way. And I think it actually flows much more into kind of the Michael Pettis view of things. Yeah. Very interesting. Thank you for the nuanced take on that. We're going to end here. I saw this last week.

24:36 really interesting, essentially, of Congressman Jim Himes, who is the ranking member of the House Intelligence Committee. I forget where he was speaking at some Warsaw city forum. It looks like, and shockingly, I think to many people, he's a Democrat and came out in sort of resounding support for the Trump administration's posture towards Europe and NATO, basically reaffirming what the Trump administration has been saying over the last couple of years, which is, hey, Europe, you need to get your economies and your military is in order. We're not here to hold your hand and do everything for you. And so actually, this is pretty interesting, considering the political polarity that exists here in the United States and the many questions

25:22 that people have with what will happen moving forward if the executive, the House or the Senate that flips blue either here midterms or during the next presidential elections in 2028. And it seems like at least with this policy towards Europe and the need for them to really bolster themselves up, at least with Jim Himes it has bipartisan support Yeah I mean look it one guy one data point but there are a few others I think we could point to over the last few months as well And I think it just interesting to see it so explicitly that basically you know don expect Democrats to liberalize Trump's trade policies because we need to re-industrialize.

26:06 Europe's got to get its act together. The free riding days are over, all this stuff. You know, if you just pulled the text out, it would look like anything that Trump or Besson have said, you know, ad infinitum over the last year. So I think it's an interesting rejoinder to, I think there's this view that among still a lot of capital allocators that, well, basically this is just, even if I agreed with some of the stuff Trump is saying, you know, if AOC is president in 2008 or Mamdani or something, like this is all going to reverse and go away. And so, you know, how seriously do I really need to take it? You know, I think this is telling you like under the hood, there are, whether you call it the deep state or the administrative state or, you know, the bipartisan consensus, whatever.

26:42 I think there are a lot of actors at play here who kind of understand the same stakes that Trump is talking about and pointing out. And, you know, they're interested in kind of maintaining that same direction to travel. And I think, you know, the tweet points it out at the bottom, but a lot of Trump's original China trade policies were continued under Biden. And actually the certain export controls over like, say, sensitive semiconductor equipment were actually ramped up and really kind of initially put into place and specked out by the Biden administration. So I think there is a general appetite for this as the military industrial complex, Congress, et cetera, grow to slowly understand these dynamics. And I think it's, you know, the wrong

27:17 move to say, you know, two years from now, it's all going to reverse. It definitely seems like a pretty clearly structural trend at this point. Yeah. That's the situation. It's been monitored. We'll be back next week.