Current developments in artificial intelligence have boosted the valuations of major tech companies, driving the overall stock market higher. However, there is considerable uncertainty about which companies will successfully develop leading products and maintain a competitive advantage to ensure persistently strong profit margins. This uncertainty naturally creates disagreements about valuations, resulting in high trading volumes and increased market volatility, according to economics professor Kellogg Sergio Rebelo.
During a recent webinar hosted by the Kellogg School of Management, Rebelo discussed five key trends that have emerged amid this volatility and their impact on the global economy.
1. Relaxation of inflation
Inflation has been closely watched since it started to pick up in 2021. The good news is that it is on the way back, with the Federal Reserve’s preferred measure of inflation (core PCE) moving closer to the Fed’s 2% target.
“High inflation is increasingly in the rearview mirror,” says Rebelo.
So far, inflation has declined without pushing the economy into a full-blown recession despite large interest rate hikes. Rebelo notes that the economy has been resilient in part because most households hold fixed-rate mortgages, which insulate them from rate hikes. Household debt servicing costs as a percentage of disposable personal income remain at about 10 percent in 2024, similar to pre-pandemic levels.
With inflation easing, the European Central Bank, China’s central bank and the Bank of England, among others, have started to cut interest rates. There is growing expectation that the Fed will follow suit and cut interest rates in September. This sentiment is reflected in the bond market. The ten-year government bond yield fell significantly.
However, despite the slowdown in inflation, prices are much higher now and are not likely to come down. “People feel that goods and services have become permanently more expensive, which is why inflation is so unpopular,” says Rebelo.
2. Labor revolution
There is a clear change in the working environment since the Covid-19 pandemic.
First, telecommuting has become common in some industries. With so many people working from home, there has been a significant drop in U.S. vehicle use — about 20 billion fewer miles driven on highways in 2024 than originally projected — and about a 30 percent drop in city subway commutes of New York.
Demand for commercial buildings has also fallen sharply. Total leased office square footage has fallen below 100 million, down from about 300 million in 2020. “This is a huge drop in demand for commercial real estate,” says Rebelo.
Meanwhile, some cities are experiencing a different phenomenon: population growth driven by remote workers. Taking advantage of the strength of the US dollar, remote workers from the US are moving in droves to cities like Barcelona, Venice and Lisbon to live and work. And this influx of people increases housing costs for locals in these cities.
“While some cities are seeing empty offices, others are experiencing a housing shortage,” says Rebelo.
Adding to the changing work environment is the rapid development of artificial intelligence, which is already beginning to fill various jobs. But it remains to be seen if — or when — it will begin to replace them.
The ChatGPT large language model has passed the bar exam, and the algorithms have analyzed four hundred combinations between chemical compounds and proteins – a task that would take humans 100,000 years to complete – in just a week.
“It is these kinds of achievements that lead many to believe that we are at the dawn of a revolution that will be bigger than the industrial revolution,” says Sergio, “and that it will happen faster.”
3. A mostly tight labor market
U.S. unemployment has remained relatively low overall, Rebelo says. While interest rates rose and remained high at the beginning of the pandemic, unemployment surprisingly did not.
One reason, Rebelo notes, is that the active labor force (people between the ages of 25 and 54) has not grown in the U.S. since 2007, making labor more scarce as the economy expands. With lower fertility rates, immigration has played a vital role in stabilizing the US labor force
This situation contrasts with the significant decline in the working population experienced by Japan and the European Union. In Europe, in particular, identity politics have led many countries to close their doors to immigration, limiting the labor force and depriving businesses of both high-skilled and low-cost labor.
“I expect labor markets to remain tight as the active labor force continues to shrink in the developed world,” says Rebelo.
4. A move towards de-globalisation
Historically, world trade has lowered prices, improving efficiency by offering companies larger markets but also more competition. The recent escalation of trade wars between countries such as the US and China, however, is poised to hurt global productivity, according to Rebelo.
The conflicts in Ukraine and Gaza have further disrupted global trade, affecting transport and raising the cost of fertilizers and other raw materials.
“There’s been a significant shift toward de-globalization,” says Rebelo. “Many companies feel less comfortable investing abroad.” For example, foreign direct investment in China fell this year for the first time.
The recent trend towards import substitution and industrial policies that subsidize local firms could lead to higher prices due to reduced scale and reduced competition.
“Economists worry that the gains from trade are being eroded,” says Rebelo.
5. An approaching tipping point for climate change
The clearest evidence of climate change—at least for wine lovers—is the shift in harvest time. Traditionally, the grapes were harvested in mid-October, but rising temperatures pushed the harvest up to mid-August in some areas.
“We are approaching a tipping point where the consequences of climate change are becoming increasingly visible, not only to winemakers but to the world at large,” says Rebelo.
Insurance and reinsurance companies, for example, have significantly raised rates for catastrophe risk insurance or stopped offering these policies altogether. The reason is that, with changing weather conditions, they can no longer rely on historical data to predict the likelihood of future disasters and set insurance rates accordingly.
“We’re starting to see climate change affect the way companies operate,” says Rebelo. “Hopefully this will encourage more businesses to help decarbonize the economy and steer us towards a more sustainable future.”
“We live in an interesting world, a world with many positives but also significant disadvantages,” he continues. “I am optimistic about the future because, as a Spanish proverb says, ‘With wine and hope, everything is possible.’
