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Here’s how I think about this… Higher rates absolutely raise financing costs, and some of those costs eventually show up in rents, business expenses and government interest payments. But that does not mean every additional hike mechanically creates more inflation. Businesses can only keep passing costs through while customers still have enough income and credit capacity to absorb them. Once demand weakens enough, pricing power starts disappearing. The Fed also does not need AI investment or defense spending to collapse immediately for tightening to work. Those areas can remain unusually resilient early in the cycle because the strategic returns are enormous and, in defense, government support is direct. Meanwhile housing, autos, commercial real estate, small businesses, leveraged companies and households are much more rate sensitive. That is how parts of the economy can still look strong while the broader credit sensitive economy deteriorates underneath. But AI is not recession proof. If recession becomes broad enough, slower revenue growth, tighter financing, weaker enterprise spending, wider credit spreads and pressure to justify massive capital commitments eventually reach AI too. The point is not that AI escapes the downturn. It is that AI can remain strong long enough to mask the deterioration elsewhere and keep aggregate investment looking healthier than the underlying cycle really is. And this is the key to the energy shock. The Fed cannot reopen Hormuz. It cannot create more oil, diesel or refining capacity. Its only real way to stop second and third order inflation is to weaken the rest of the economy enough that businesses can no longer keep passing higher energy and freight costs through, while workers lose enough bargaining power that wages stop chasing those increases. That means tighter credit, slower spending, weaker investment and softer hiring. Taken far enough, the mechanism essentially requires recessionary conditions. I do not view recession here as some accidental side effect policymakers failed to foresee. If inflation is being sustained by forces the Fed cannot directly repair, preventing those pressures from becoming embedded may require enough demand destruction to push the economy into recession. There is also a much larger geopolitical dimension. The dollar remains the dominant funding currency of the global financial system. Keeping U.S. rates elevated does not just tighten American credit. It raises the cost of dollar funding across the world through currencies, sovereign yields, corporate dollar debt, trade finance and bank funding. Countries earning revenues in local currency while servicing dollar liabilities become increasingly vulnerable. And eventually the world remembers who ultimately supplies the dollars. The Fed maintains swap lines and liquidity facilities because global dollar shortages can become destabilizing. So the longer U.S. rates remain elevated, the tighter global dollar liquidity becomes. At some point, foreign financial systems may again need access to Fed supplied dollars. My base case is straightforward. Energy and supply constraints keep inflation elevated. AI and defense temporarily keep parts of the economy looking stronger than the underlying cycle. The Fed stays restrictive. The rate sensitive economy keeps weakening. Global dollar funding tightens. Recession broadens. Eventually even AI capex and other resilient sectors begin to slow. Then unemployment rises, spending weakens, credit creation contracts and pricing power collapses. That finally creates the disinflation needed for aggressive cuts. I would not frame this as the Fed accidentally stumbling into recession. If inflation is supply driven, stopping its second and third order effects may require enough demand destruction to create recessionary conditions. Because the dollar sits at the center of global finance, that tightening does not stop at U.S. borders. It squeezes the world too.

onechancefreedm ↗