The macro landscape for the next ten years: the first five years of "persistent inflation," followed by five years of "super deflation"?

Bank of America Merrill Lynch’s latest research report depicts a sharply divided decade-long macro outlook: an AI-driven capital expenditure boom combined with “hot” fiscal policies will keep inflation pressures elevated in the near term, while in the early 2030s, the productivity revolution sparked by AI could trigger one of the most profound deflationary cycles in history. This framework is reshaping investors’ fundamental judgments on interest rates, credit, and asset allocation.

According to Chase Wind Trading Desk, Bank of America Merrill Lynch strategist Haim Israel’s latest report states that the global economy is approaching a technological “singularity”—a nonlinear inflection point where existing economic models and valuation frameworks will fully break down. The core logic is: from 2025 to the early 2030s, massive capital investments in energy, data centers, infrastructure, and other sectors will continue to push inflation higher; meanwhile, around 2031 to 2035, the productivity leap driven by AI will lower costs in energy, healthcare, food, and manufacturing, triggering a potential historic-scale deflation wave.

This judgment’s direct market impact has already become apparent. Bank of America Merrill Lynch notes that the current market adjustment is mainly driven by rising real yields rather than a collapse in long-term inflation expectations, implying that duration assets are under pressure while credit spreads remain relatively resilient. Accordingly, they recommend reducing duration, increasing spreads, and favoring municipal and investment-grade credit bonds over Treasuries within fixed income, while tilting toward floating-rate credit products and equities.

Approaching Technological Singularity, AI Reshaping Cost Curves

The report cites Haim Israel’s framework, noting that over the past decade, humanity has achieved breakthroughs in DNA editing, black hole observation, sustained nuclear fusion reactions, using only about 1% of available global data, while current computing power is tens of thousands of times stronger than during the Apollo era and costs have fallen sharply.

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

However, this transition is currently capital-intensive and inflationary. The report estimates global related investment needs exceeding $9 trillion, covering energy, data centers, water resources, copper, lithium, land, bandwidth, and grid infrastructure. Renewable energy and nuclear power (especially small modular reactors, SMRs) are seen as key supports for AI infrastructure.

“Hot” Fiscal Policies and AI Capital Expenditure Form a Self-Reinforcing Cycle

Bank of America Merrill Lynch believes the current macro environment features a “policy hot run” and AI capital expenditure boom reinforcing each other. The report notes that under the context of the OBBBA Act and wartime spending, U.S. nominal GDP growth in Q1 2026 is projected at 6.0% year-over-year, higher than the 10-year average of 5.5% and the 20-year average of 4.4%, and on par with the 50-year average—including the high inflation periods of the late 1970s and early 1980s.

The key transmission mechanism is the “wealth-reinvestment cycle”: U.S. household wealth increases by about $15 trillion annually, combined with a stock of $184 trillion, continuously flowing into consumption and investments in AI, energy, and infrastructure, expanding supply while maintaining demand. Bank of America Merrill Lynch projects that, based on current trends, household wealth will grow from $184 trillion at the end of 2025 to about $214 trillion by the end of 2027.

Against this backdrop, 5-year and 5-year forward inflation swaps are anchored around 2.45%, and the 10-year real yield remains high at around 2.0%. The report suggests that inflation expectations remain stable partly because markets anticipate the Federal Reserve, under Warsh’s leadership, will continue Powell’s credibility, and because markets have already priced in the deflationary pressures from AI in 2030–2035.

Spread Peaks, Yields Not Yet Peaking

Last month, Bank of America Merrill Lynch’s “Persistent Ceasefire = Bullish” logic was validated in risk assets and credit spreads but did not work in the rate direction. The report notes that high-yield spreads have narrowed before reaching previous highs, suggesting that peak yields on investment-grade bonds seem to have been established; meanwhile, long-term U.S. Treasury yields have risen to new highs for the year, with the 10-year yield breaking above 4.4% resistance to 4.47%, with technical analysis indicating further upside toward the 4.55%–4.75% range.

Market expectations for the Fed’s path have also shifted significantly: from a forecast a month ago of about 9 basis points of rate cuts by year-end, to now expecting about 16 basis points of hikes. Bank of America Merrill Lynch’s economic team has delayed two rate cuts from September–October 2026 to July–September 2027, citing persistently high core inflation and its ongoing rise, strong April non-farm payrolls, and hawkish statements from Fed officials.

In this environment, Bank of America Merrill Lynch maintains a cautious stance on duration but remains constructive on credit. Recent recommended assets include municipal bonds (core and high-yield), leveraged loans, institutional MBS CMO floating-rate products, AAA CLOs, preferred stocks, and short-duration investment-grade/high-yield bonds.

Floating-Rate Credit Outperforms Duration

Based on the above framework, Bank of America Merrill Lynch provides a clear asset allocation direction. In an environment of structurally strengthening nominal economy, they favor floating-rate credit products represented by BB-rated CLOs over duration assets, and overall equities over fixed income. For investors needing to hold duration exposure, long-duration municipal bonds and investment-grade credit bonds are considered more attractive than Treasuries, as they can generate yields without relying on rate declines.

Regarding credit spreads, Bank of America Merrill Lynch sees the possibility of further narrowing in 2026, even reaching historic lows. The report notes that the high-yield spread peaked at 335 basis points in 2026, significantly lower than the 435 basis points in 2025, and the peak occurred earlier, reflecting reduced market risk tolerance ahead of the 2026 midterm elections under the Trump administration.

In agency MBS, the report suggests that current spreads (113 basis points) are still relatively rich compared to the 10-year Treasury yield, but if a ceasefire agreement persists, MBS spreads could further narrow. High-yield bonds are currently viewed as the most inexpensive sector, with agency MBS OAS narrowing 32% since late 2021, while high-yield OAS has only narrowed 6% in the same period.

Unavoidable Structural Costs

Bank of America Merrill Lynch’s report also highlights that this technological transformation comes with profound social risks. About 1 billion workers will need to undergo skill reshaping amid widespread AI adoption, as traditional education and credentialing systems rapidly depreciate. The report also lists mental health risks (loneliness, depression) as a “third-largest economic-scale” social issue.

On the technological front, accelerated integration of AI and quantum computing could reset cryptosystems, financial architectures, and even technological design within this decade. Merrill Lynch emphasizes that this is not a cyclical tech rotation but a civilizational-level systemic shift, with deep and lasting impacts on valuations, labor, energy, and social stability.

Recently, the Nasdaq 100 index surged over 25% in six weeks, and Bank of America Merrill Lynch believes this indicates the pace of the above transformation may be faster than previously expected.

All the above insights are from Chase Wind Trading Desk.

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