AI’s App Store moment and the Fed’s latest hike

In this blog, we will discuss Chat-GPT’s app store moment and the Fed’s latest interest rate hike, where we discuss its progress in the fight against inflation.

AI’s app store moment

In software, accessibility is the most important thing. GPT-3 was released in 2020 without much fanfare. It was only when it was incorporated into chat mode (in Chat-GPT) in November 2022 when its popularity exploded. It became the fastest app to reach 100 million users (taking only two months to accomplish this feat). 

PS: The second fastest-growing app is TikTok, which achieved that same milestone in nine months. Unlike other viral apps, though, ChatGPT is not a social media app, a chat messenger, or a P2P payment system. It does not have any embedded viral loop or network effect. Nothing about how it works inherently promotes organic growth, other than the fact that its capabilities are breaking our existing mental model of what a computer should be able to do. To me, this makes the growth rate even more amazing. 

As discussed last week, you can think of Chat-GPT as a natural language interface for users to interact with their computers. But computers are of limited use if they cannot interact with the internet or interface with the outside world (recall that Chat-GPT 4 is trained only with data until September 2021 and is not connected to the internet).

This past week, OpenAI made an announcement that will change this. The company announced that ChatGPT would be capable of interacting with the outside world via plug-ins (currently in Alpha mode). Plug-ins allow the core Chat-GPT 4 applications to interact with other services and the external world. 

The developers described this as AI getting “eyes and ears.” With this, users can browse the web (using Bing search API) and upload proprietary data to Chat-GPT 4. It can also order food, look up flights, engage in e-commerce, and carry out many more actions as more plug-ins are created. In a way, it’s similar to when Apple launched the App Store, which supercharged the functionality of the iPhone. 

But unlike mobile apps, building the plugin for Chat-GPT 4 is very easy, as it uses natural language. Even though the whole concept is experimental, it shows a glimpse of the future. As a technologist, I have to marvel at the creativity of the OpenAI team. This approach is a really efficient way to bootstrap GPT with a robust knowledge graph. And if we continue with the app store analogy, with OpenAI and Microsoft as the iOS, we need a competing Android equivalent “AI app store.” Google needs to catch up fast. 

Fed’s increased the interest rate again

In its meeting in March 2023, the Fed raised interest rates by another 0.25%, which allows them to target a Fed funds rate between 4.75% to 5%. This is the ninth straight meeting where they have done so.

Before this meeting, some investors believed that the Fed might pause interest rates hike due to the increased uncertainty in the banking sector. This move reaffirms the Fed’s belief that persistent inflation poses a greater threat to the economy than volatilities in the banking sector. 

So it’s worth pausing and looking closer at where the inflation is coming from and if we are close to taming it. The chart below, from the economic research done by the San Francisco Fed, shows the breakdown of core PCE, the Fed’s preferred measurement for inflation, because it more accurately reflects consumer spending. 

The blue bar represents demand-driven inflation, the orange represents inflation drivers of unknown causes, and the green is due to supply chain disruption. Blue is the one that the Fed can hope to control, albeit so with a very imprecise tool. 

Here’s an oversimplified chain of events that the Fed hopes to accomplish. By increasing interest rates, the Fed aims to do the following:

• (1) Increase borrowing costs: As interest rates increase, the cost of borrowing for businesses and consumers also rises, making loans and credit more expensive
• (2) Leading to a stronger USD: Higher interest rates can attract foreign capital as investors seek higher investment returns. This can lead to an appreciation of the USD, making US imports cheaper and reducing inflationary pressure
• (3) Reduce spending: Higher borrowing costs can lead to reduced spending by businesses and consumers, as they may delay or cancel plans for new investments, expansions, or purchases due to the increased financial burden
• (4) Which slows down economic growth: With businesses and consumers cutting back on spending, the overall demand for goods and services decreases, leading to slower economic growth
• (5) Leading to a tighter labor market: As businesses face reduced demand and higher borrowing costs, they may be less likely to hire new employees or increase wages. This can help to control wage-driven inflation
• (6) And finally, achieve lower inflation: The reduced demand for goods and services puts less pressure on prices, as businesses may need to lower prices to sell their inventory or maintain market share. This helps keep inflation in check

PS: Increased interest rates also have the effect of reducing equity prices, lowering investors’ portfolio values. This reduces the Wealth Effect, making people feel poorer, which can further lower consumer spending.

That’s a lot of connected events that must happen for the Fed to achieve lower inflation. Let’s account for where we are in the fight against inflation. (1) and (2) have occurred. As shown in Figure 4 above, we know that (3) has not been achieved yet. The demand-driven inflation (blue) is still flat. 

The economic growth data (4) is not out yet. But the high-frequency economic indicator seems to suggest that the economy is still growing.

We also know that (5) is not achieved. Currently, the unemployment rate is still very low. Despite the layoffs in the tech sector (Amazon announced another 9,000 job cuts recently), the broader job market in the US economy is still tight. The US unemployment rate is at 3.6% as of the end of February 2023, a multi-decade low. 

As you can see, the job is only half done. The Fed will continue to increase (albeit in smaller increments) and hold this interest rate level longer until more economic indicators go their way.

PS: the fact that the stock market rebounded after the Fed’s latest announcement indicates that the Fed has not successfully tamed investors’ bullish psychology.