The "Macro Picture" of the Next Decade: Persistent Inflation in the First 5 Years, "Super Deflation" in the Last 5 Years?

Bank of America Merrill Lynch's latest research report paints a sharply divided ten-year macro picture: an AI-driven capital expenditure boom overlapped with "hot running" fiscal policies will maintain inflation pressure in the near term, while in the early 2030s, the productivity revolution sparked by AI may usher in one of the deepest deflationary cycles in history. This framework is reshaping the basic judgments of investors regarding interest rates, credit, and asset allocation.

According to Chase the Wind Trading Desk, Bank of America Merrill Lynch strategist Haim Israel's latest report points out that the global economy is approaching a technological "singularity"—a nonlinear turning point where existing economic models and valuation frameworks will completely fail. The core logic is: from 2025 to the early 2030s, massive capital investment in energy, data centers, infrastructure, etc. will continue to push up inflation; around 2031 to 2035, AI-driven productivity leaps will lower costs in energy, healthcare, food, and manufacturing, triggering a potentially historical level deflation wave.

The direct impact of this judgment on markets has already begun to emerge. BofA points out that the current market adjustment is mainly achieved through continuously rising real yields rather than the collapse of long-term inflation expectations, which means duration assets are under pressure while credit spreads remain relatively resilient. Therefore, the bank advises investors to reduce duration, increase spread, and prioritize municipal bonds and investment-grade credit bonds over government bonds within fixed income, while tilting toward floating-rate credit products and equities.

Technological Singularity Nears, AI Reshapes Cost Curve

Bank of America Merrill Lynch's report cites Haim Israel's framework, highlighting that in the past decade, humanity has achieved breakthroughs such as DNA editing, black hole observation, and sustained nuclear fusion reactions while using only about 1% of available global data. Current computing power is trillions of times stronger than in the Apollo era, with significantly lower costs.

The real impact of AI is not in chatbots, but in simulation, optimization, and autonomous systems. The report lists concrete data: drug development cycles compressed from 10 years to 30 days, costs reduced from billions of dollars to millions, with success rates approaching 100%; in material science, millions of new materials can be discovered within weeks. Battery, agriculture, weather forecasting, and energy systems are being thoroughly reconstructed.

However, this transformation is capital-intensive and inflationary in the near term. The report estimates global investment demand exceeds $90 trillion, covering energy, data centers, water resources, copper, lithium, land, bandwidth, and power grid infrastructure. Renewable energy and nuclear energy (especially small modular reactors, SMRs) are seen as key supports for AI infrastructure.

"Hot Running" Policy Forms Self-Reinforcing Cycle With AI Capital Spending

BofA believes the current macro backdrop presents a situation where "policy hot running" and AI capital expenditure boom mutually reinforce each other. The report notes that, under the OBBBA act and wartime spending, US nominal GDP growth in Q1 2026 reached 6.0% year-on-year, higher than the 10-year average of 5.5% and the 20-year average of 4.4%, equaling the 50-year average—which includes the high inflation periods of the late 1970s and early 1980s.

The key transmission mechanism is the "wealth-reinvestment cycle": US household wealth increases by about $15 trillion annually, added to a base of $184 trillion, continuously flowing into consumption and investment in AI, energy, and infrastructure, expanding supply while maintaining demand. BofA estimates household wealth will grow from $184 trillion at the end of 2025 to about $214 trillion by the end of 2027 at this rate.

Against this backdrop, the 5-year/5-year forward inflation swap is anchored at 2.45%, and the 10-year real yield stays high at about 2.0%. The report believes the stability of inflation expectations is partly due to market expectations that the Fed under Warsh will maintain Powell's credibility, as well as the market pricing in the AI-driven deflation pressure expected from 2030 to 2035.

Spread Peaks, Yields Have Not Peaked

BofA's "lasting ceasefire = bullish" logic from last month has been validated in risk assets and credit spreads, but not in interest rates. The report notes the high-yield bond spread narrowed without reaching previous highs, and the peak in investment-grade bond yields seems to have been established; in contrast, long-term US Treasury yields have reached new highs for the year, with the 10-year yield breaking the 4.4% resistance to 4.47%, and technical analysis suggests further upside to the 4.55%-4.75% range is possible.

Market expectations for the Fed policy path have also shifted: from expectations of a 9bp rate cut before year-end a month ago, to expectations of a 16bp hike. BofA's economics team has postponed its two rate cut expectations from September-October 2026 to July-September 2027, citing high and rising core inflation, a strong April nonfarm payroll report, and hawkish comments from Fed officials.

In this situation, BofA remains cautious on duration while constructive on credit. Recently recommended instruments include municipal bonds (core and high-yield), leveraged loans, agency MBS CMO floating-rate products, AAA CLOs, preferred stocks, and short-duration investment-grade/high-yield bonds.

Floating Rate Credit Preferred Over Duration

Based on the above framework, BofA provides a clear asset allocation direction. In a structurally strong nominal economy, the bank believes floating-rate credit products represented by BB CLOs are preferred over duration assets, and equities overall are preferable to fixed income. For investors required to hold duration exposure, long-duration municipal bonds and investment-grade credit bonds are considered more attractive than Treasuries, as the former can earn returns without relying on lower rates.

Regarding credit spreads, BofA believes the possibility of further narrowing and even record lows for spreads in 2026 cannot be ignored. The report notes the peak spread for high-yield bonds in 2026 (335bps) is significantly lower than the 2025 peak (435bps), and the peak appears earlier, reflecting the Trump administration's decreased tolerance for market risk as the 2026 midterms approach.

In agency MBS, the report notes the current spread (113bps) remains expensive relative to the 10-year Treasury yield, but if the ceasefire agreement persists, further narrowing is possible for MBS spreads. High-yield bonds are currently seen as the relatively cheapest sector; agency MBS OAS has narrowed by 32% since the end of 2021, while high-yield OAS has only narrowed by 6% over the same period.

Structural Costs Not to Be Ignored

BofA's report also notes profound social risks accompanying this technological transformation. Around 1 billion workers will need to reskill as AI agents spread massively, and traditional education and certification systems are rapidly depreciating. The report also lists mental health risks (loneliness, depression) as a social issue on the scale of a "third largest economy."

At the technological level, the accelerated integration of AI and quantum computing may reset encryption systems, financial architecture, and even technical design itself within this decade. BofA emphasizes this is not a cyclical tech rotation, but a civilization-level institutional shift, with deep and lasting impacts on valuations, labor, energy, and social stability.

Recently, the Nasdaq 100 surged more than 25% in six weeks, and BofA believes this trend shows the pace of transformation may be faster than expected a few weeks ago.

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The above exciting content is from Chase the Wind Trading Desk.

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