AI earnings and equities, gauging Bessent’s success and Iran’s economic squeeze

It's Friday the 27th of August, and this is your capital, economics, weekly briefing. I'm David Wilder, coming up. Will, tighter U.S. sanctions, squeeze around the economy enough to force capitulation, but first, kneels out. So I've got Jonas Golderman with me, our chief markets economist, who's back in the hot seats to talk about the big issues moving stocks, bonds and currencies. Hi, Jonas. Welcome to the last podcast of the summer. Hi, David. I should time stamp this conversation because it's coming on midday in London. We are post-NVIDIA earnings, pre-the-market open and pre-keven washes, Jackson Holder parents. I wanted to ask about those in video earnings. They blew past the consensus. They're also coming on towards the back end of a pretty subdued August for equities, for the S&P 500. Will these earnings, do you think they're going to be enough to give the market back some of the vava boom around AI that's been driving stocks? Well, I think there's a good chance. Well, yeah. I mean, in video's been from the start of the AI boom, really at the heart of it all. It's been probably the key bell weather for how the broader AI ecosystem AI boom is doing. They're increasing. It's also a load bearing wall, not just in terms of supplying the chips, they run the AMOs, they go into the data centers and make up such a huge part of the cap expanding, but also increasing. They're involved in financing other parts of the AI system, the smaller companies and data centers and so on. One way of thinking about it is they are becoming more vertically integrated company. It's like advantage of a boom. The counterpoint is that some of these financing flows are some sort of circular and that's one of the concerns that has been prominent over the recent months. Let the earnings were pretty good across the board, beating expectations comfortably. Guidance was very bullish, but as we've gotten used to in some sense from this company, yeah, and the stock that was up about 4% to after hours, futures in the US for the main, you know, for the main indices, and especially the tech indices, wanting to green it this time. So we'll see whether that holds when the market opens. Now, is this going to be enough to spark another like higher? I guess the way I think of it is it's probably a necessary condition, but it may not be a sufficient one. I think we need a good news from everybody that's following on from generally strong reports from the other big tech firms and actually sort of across the market, it's been a very strong earnings season. So the numbers certainly support our view that there is another probably final leg higher in the stock market into year end, but there are still some exact signals out there in terms of the forward looking indicators or things like, you know, track various indices for compute prices, token prices, etc. The adoption of the sort of frontier models and how their revenues doing, which is based on news reports rather than since they're not public yet. And those are a bit more mixed. The narrative is still not struggling to fully recover from the June, July period, so just a bit of a reset. It's still a bit muddled. So we'll see whether there is enough fuel for another, you know, five, ten percent rally or so, which is what we forecast into end year. At the same time though, it does seem as though for all the good news in these earnings and in other earnings that we've seen this season, there does seem to be these nagging concerns. Even as Nvidia was reporting, everyone was talking about this, this issue of circular financing, how Nvidia has been helping support its customers to buy its goods. Lots of questions about whether the AI investment boom has gone far too far that we're looking at massive over capacity in this build-out competition from China. So all of these factors, what influence are they going to have on the market? Yeah, I think you're right. There's a growing number of red, orange and hitable peps, orange still signals on flags around the sustainability of the boom. Our assessment is that we are coming towards the end of this massive equity boom, but that they will be followed by a major correction next year, and that the market will not be built to sustain these kind of gains for all that much longer. You know, among those red flags, you know, the circular financing point that you mentioned, there's the signs that AI models are becoming increasingly commodified, you know, that there's so much competition between different models and competitors just looking to use the cheapest, the most efficient one. So it's unclear whether the model companies can sustain the kind of margins that they will need to keep financing their data center build-out. You look at valuations, you know, in some sense, it's been a reset if you look at just the sort of toldman forward measure of price earnings that we look at, but a lot of that depends on earnings expectations, which are still, you know, extraordinarily high, that's sustaining. So it's not that much comfort there. If you look at the sugar cape index, for example, which looks at a longer term average of earnings, which is probably the most sustainable rate, well, on that measure, we're getting close to early 2000 levels. The cape indexes are cape measures is above 40 now. That's worrying, I think. And then you have the sort of extraordinary, well, the amount of issues of equity that we're seeing or the start of the year is getting towards not quite the dot-com levels, but it is spiking higher, you know, we have the SpaceX and then Google issuing huge chunk in June and we're expecting. I'm dropping, perhaps also, open AI based on reporting. They will be IPOing greater this year, at least one of them, that would be another big slug. And typically, sort of big surges in equity issuance in the US is a sign that you're getting close to a peak, you know, we look at, as fat as a great data source on this, which is, you know, tracks the gross equity issuance in the US. And there are three big spikes in that series going back to the 90s. One is the dot-com era, one is 2007, and one is 2021, sort of the pandemic era excess in the equity market. And each of those years was followed by a bear market the following year. And we're seeing another spike in that series right now, which is why our best guess is that next series is going to be a tougher one, much tougher one for the equity market. Speaking of the Fed, Kevin Walsh's first comments delivered to this annual Fed symposium of Jackson, holding Wyoming at his first as Fed chair. There's been an enormous amount of debate about what Walsh should and shouldn't be communicating to the market as Fed chair. To what extent is uncertainty surrounding the Fed affecting the market outlook? I think that's more of an issue for the bond market than equity. There's probably part of the reason maybe that equity markets didn't fluctuate in August, but I don't think that's the main story. I mean, look, Walsh, it's his first keynote speech of Jackson whole. It has become this big, it's had peace event, and especially the first speech by a new Fed chair is seen as important, setting the tone for his term in office. That's how previous Fed chair's power used to that way, but not yet on yelling. And in this case, I guess there's doubly important because his last public performance after July for MC meeting did not go down particularly well at all with the bond market. There was a contributing to setting off this mini sell-off that we've seen at the long end of the Treasury market, sending a 38-year-old to its highest level since 2007, which has people worried. So he needs stronger performance to offset that. I think what we are looking for analysts and that I imagine the market as well is looking for his clarity. He's come out strong against forward guidance, so no one's expecting him to tell us what he's going to do in September or later this year in terms of the policy way. And that's fair enough, that's how he wants to approach it, but he needs to set out a clearer framework for how he is going to go about setting policy or contributing to setting policy because that's a committee decision, but also for how he plans to communicate and what we need to know what we should expect for him, and so far he's, you know, he said a lot about what he doesn't want to do, but he has said a lot less about what he is going to do, especially in terms of how he is going to be communicating policy and what is the framework that Fed is going to be operating now. He wants to change it, but how much does he want to change it? Is the key question. You mentioned the bond market. This uncertainty around the Fed is having a greater influence on bonds. We're speaking at the end of a week where we've seen yields at the long end coming off after that big sell-off last week. Let me put it to you. Scott Besson's intervention in the treasury market. What? It succeeded. Long in the yields of stock rising. What do you think? I mean, you can make that case. It has worked to some degree. Same for that matter with the intervention with the yen, which was, you know, hasn't rallied enormously, but it's stabilized over August. So it is working to a degree. It's been helped, I think, by some softer US data, six of a hawker shift underway in the bank of Japan, the energy prices, stabilizers, come down a bit recently. So there's an element of rock here as well as his intervention succeeding, but you know, even since you make your own look, he picked a decent, you know, good point where the market has felt a bit overshot a bit when on the end term way. And then so he picked this spot. You know, he is a former hedge fund manager, so that's part of his persona, if you will, sort of poacher, turn gamekeeper and he may be patting himself on the Mac right now, recently. So, obviously, the neither in the case of the yen or in all the treasury market, you know, these interventions are pretty small in terms of the money involved, but the signal is what matters, and it has had some effect. But the problem is that the steps don't address the underlying issue, especially not in the treasury market. You know, when it comes to the yen, I think they're they're a better shot of success, we agree with his view. the end is significantly undervalued I think that's a pretty widely held view and if the fundamental continue to shift on that front especially if the bankage pan does pick up the pace of its monetary tightening as we in and now many others are expected to do over the autumn that may turn the tide on that front on a more sustainable basis. When it comes to treasuries I think at least in the short term the upward pressure on yields is going to remain quite strong and there's two reasons for that the first is as everyone knows by now or has known for a long time. US fiscal policy is is on an unsustainable path that's the underlying issue it's not that there's been significant news on that front over the past month that has sparked a sell-off but that is the underlying you know core of the problem and there's a similar situation in several other major economies UK France etc so the market you know is the prime market is having to absorb enough a lot of government bonds and you know you issue more bonds the price of them is going to then to go down all else equals right and we're in a situation here where you know it's sort of the natural bias of long-end government bonds like pension funds and insurers and so on you know that that capacity to absorb this issuance is stretched and so you're needing other buyers to come into the market tend to be more biosensitive and that's that's a sort of the underlying thing putting up a pressure on term premium that are not and are yields it's not going to be solved by this buyback staff for the suggestion that they're going to draw on the treasuries count at the Fed sort of the checking count if you will like that neither of those things do anything to change the net that position of the government you reducing long-end issuance further it might help to a degree but it's it's more of a sticking plaster than a solution what needs to change is fiscal policy which is not for the treasury secretary within the president to set that's decision by congress and given the deadlock there and given that that's probably going to get worse after the midterms if the democrats take control of the house so it seems quite likely that the problem is not going away the second reason that yields are relatively high and and may remains it for a while is is more positive and that is that the US economy is doing pretty well right now it's growing quite fast relative to the recent past and there's an investment massive investment boom underway that increasingly increasing the issues of debt so across conning the corporate sector as well look historically long-end treasury yields have corresponded roughly to nominal growth and expectations for future nominal growth at least outside of recessions and unusual exceptional periods like the pandemic and up the moment use nominal GDP growth is close to 6 percent so 38 yields that are around above 5 percent is really not surprising in that context and the idea that this line that Bessent has at the market is not trading in line with fundamentals I think that's just I don't buy that at all and I think that's a fairly widely healthy in the market now so in the short term yields likely to stay high and then they may have to go back into you know the bag of magic tricks to try to do something amount up but I don't think that this kind of sticking plaster approach is going to to work I was going to say it doesn't sound like we've just seen Scott Bessent's last intervention in the markets no he's a quite an activist treasury secretary I think he he seems to enjoy it to a degree this sort of typically treasury secretaries or sort of technocrats in general they tend to be risk of us and they stick to the the way things are done and that's not always a good thing but that's how they tend to approach it Bessent and Trump are different they lean into risk of leaning into the unconventional for better or worse and some reasonable success in the short term here they may actually embolden them to try more so we'll see what they have in mind during his ultimate there on Scott Bessent's interventions on the Fed's influence on the market and on those Nvidia earnings our capital daily publication is out each trading day it gives you forward looking commentary about how macro forces are driving markets I'm going to add the latest one to the podcast notes because that looks at why tech earnings haven't been lifting stocks of late super relevant for that discussion with Jonas if you're not already a capital economic subscriber you can visit our website capitaleconomics.com and start a trial of our services today now at the start of this week Scott Bessent announced economic D-Day for Iran with new sanctions that target Iranian commercial and financial linkages as well as the threat of sanctions on countries that do business with Tehran what the Trump administration is calling Operation Economic Outcast is designed to apply a further economic squeeze that forces Iran to do a deal but will it work to find out I spoke to chief emerging markets economist William Jackson and I started by asking him what we know about the state of Iran's economy I think the starting point is we get very little information on how Iran's economy is really doing but we can determine that it's in a very difficult situation even at the start of the year before the war had started we saw large scale protests in Iran by the people who are against the regime about the economic conditions high inflation weak economies sanctions and so on so the economy was already in a really weak point now the war is led to large scale physical destruction of infrastructure and a ton that needs to be rebuilt I suspect that's leading to money printing that will fuel inflation the reports we see suggest the inflation might already be running at about 80 percent and Iran's oil exports have been squeezed by the US blockade that was on before the memorandum it was everyone's understanding was agreed back in June and we've seen more recently in Iran's economy is utterly dependent on for elects go to any hard currency income to finance its imports harrassments suggest that is these oil exports have gone pretty much to zero so that could be leading to shortages we see again reports of waste-scale fuel shortages I'm sure there are similar problems for lots of other goods too so it's in a very difficult situation so it doesn't sound like there's much in terms of timely series data points to get a grip on exactly how the economy is performing so all the kind of indicators that you're looking at yeah there's there's not really anything coming out of Iran itself but we can use a few things well one of which this widely looked at is is how the exchange rate is doing on the parallel market outside the foreign exchange system and we've seen that collapse really since since the beginning of the war and take it further leg down a lot and five percent against the dollar since we got the announcements that this economic do they was was in the works and they're falling the exchange rate is clear sign that the economy is suffering from a squeeze on hard currency income and therefore in the exchange rate slightly to push inflation up even further and the other the other thing we can look at is Iran's trading partners one one piece of the data point we're looking at quite close is what the Chinese trade data show prior to the war China along with the UAE was Iran's largest source of imports so if we look at what China's data we're showing we can get a sense of the extent to which Iran is importing goods these have been falling by 70 percent plus in your idea terms so very large collapse in import demand and probably domestic demand too so these are the kind of indicators we're we're having to be quite quite creative speaking of getting creative I think one of the challenges that your team faces is that shipping activity coming in it in and out of the straight of Hormuz has become quite quite murky hasn't it a lot of ships switching off their transponders are going dark effectively as they're exiting the straight so when you talk about this collapse in oil export revenues is there perhaps a sense that oil is getting out is being sold through these sorts of channels it's not clear to us that there is much oil at all being sold there are various bodies that are tracking trying to get as good an estimate possible as of these shipping flows and very little seems to be getting out on the right side through the straight there might be trickles the the things that are slightly harder to measure through Iran are what what's going over that there's probably been an attempt to shift oil via overland routes but I think they'll be very small in scale compared to anything that goes by sea the other the other question mark is about Iranian oil that's held outside the straight at oil at sea I think that during the first US blockade before the June memorandum of understanding was quite important in giving Iran something of an economic lifeline but from what we know the the Iranian oil held us see as much smaller now so it can't get as much revenue and with the tightening of financial sanctions on Iran has become harder to sell that as well yeah talk about those financial sanctions you're speaking a few days after Scott Besson announced more sanctions that are targeting financial links with the country targeting the the the countries that do business with Iran how effective do you think these sanctions are going to be in applying a further squeeze on on the economy it could seem that these are aimed at closing any loop holes that Iran might be able to find and we've seen the exchange rate fall further on the parallel market so it does suggest that there is some squeeze that's happening but I think the two points I read emphasize the first is that the real squeeze on Iran's economy is coming from the from the military blockade of its oil exports through the strait economy so that that is the main the main form of the squeeze on Iran's oil exports the sanctions that have announced will be I think minor compared to that the The other point when it comes to sanctions is really to make these effective, they would need to target China, 90% of Iran's oil exports go to China. Iran is very dependent on imports from good China, so that's the really crucial relationship for Iran. But it does seem like the US is treading quite carefully there, partly because China has tools that it could use to retaliate, for example, it's leverage over at RareFs, and also we have the Trump sheet meeting this planned in for September, and it seems like the US would be unlikely to want to raffle feathers and ahead of that. So putting all of this together, I don't expect you to tell us when a deal is going to be done that finally ends this standoff. So perhaps a better way in is to talk about what might be happening within the Iranian government in Tehran in terms of this economic squeeze, because there have been signals coming out of the government that the sun might be feeling pressure to get some kind of deal done, right? It's true that we have seen more publicly reported comments from moderates within the Iranian regime, including the president suggesting that Iran used to negotiate from a position of strength. It does appear that they are increasingly concerned about the state of the economy and possibly the threat to when you protest like we saw earlier in the year, and we've also seen a bit more momentum on the Iran-Oman negotiations to establish a agreement over a future in shipping routes through the strait of economies. And if that's agreed, that might at least settle one of the ambiguities that was evidence in the mirror had to move on, standing in June and led to its collapse. But at the same time, we know that hardliners within the Iranian regime are in a very strong position. There are various reports that these original failure of them can never end up understanding undermined the bargaining position of some of the more moderate factions within the Iranian regime. And I think there's very notable from history, looking through history, that there are regimes that have survived a very long time in the face of economic collapse and widespread US sanctions, where you could Cuba after the 1959 revolution, there was a large fallen import. regime is still in place, back to Venezuela in 2012, again, the economy collapsed, but with these patronage repression in the regime lasted for a long time. So there's no guarantee looking through history that these kind of blockades will work. So this weekend is the six-month anniversary of the start of this conflict. It sounds like there's a risk that it could well drag on for months more. Yeah, I think we're clearly seeing that this is not a short conflict that's going to be over in a lot of time. I think the war in Ukraine is a sort of ominous sign of how a conflict can drag on for a very long time, when neither side is in the ascendancy and conspicure military advantage, and when there's a vast gap in what either side would consider a reasonable negotiated outcome. So it does feel like, and with the Iran war, it does feel like there's a possibility that this continues for quite a long time, where we have hardlineers in Iran, quite entrenched and willing to tolerate quite a lot of economic pain, and the US not willing to concede to Iran's demands around straight-up or moves. And in the meantime, we're likely to seek further efforts to try and get Oral out, whether circumventing straight via the Red Sea, building more pipeline and other infrastructure across the Gulf countries and so on. William Jackson there on Iran's economy after six months of war, military blockade and sanctions, I will add his recent report on Iran's economy to the podcast notes. But that's it for this week. We will be back next week with more from the world of macro and markets. Until then, goodbye.