The Week Ahead - The Great Unwind

Democrats did a good job. I really do. I think they did a good job. They fought hard, and they'll send over things that are insane, and I'll veto them. And after a couple of months of vetoes, they'll go all, and they'll say, how do we get this stuff done, and we'll work together. Hello, and welcome to the week ahead on the Morapodcast. My name is Dominic Bunning, head of G10 FX strategy in London, and today is the 6th of November. Well, it's been an absolutely monumentous week. Not just in markets, but in politics, with the US midterm election results showing a huge swing towards the Democrats, and even President Trump, as you heard at the start of the podcast, they're accepting that the Democrats certainly did a good job, but also suggesting that it could be challenging for them to work that closely with Trump, which does point potentially to some signs of policy stagnation in the years ahead. Markets have had a really tough week in light of those results with equity markets, in particular, coming under some pressure on the fears that we could see greater regulation around AI, both in terms of the software build-out, but also the hard build-out of data centers in various jurisdictions. And that's really put a bit of weight behind this pullback in US equity markets. That said, just as we record this, we've just had the results of the latest labour market data in years, which was absolutely rock solid, very strong gains across the board. So we'll be talking about that, about next week's US CPI data, and obviously about the implications of the elections with our chief US economist, Jeremy Schwartz. We've also in Europe had some pretty interesting central bank decisions with the Bank of England hiking, the Ricksbank hiking, and the Nordic Bank leading rates on hold. We'll be talking through all of those things with Josie Anderson, one of our European economists. And we've also got Sinalvarma, our chief economist for Asia-X Japan, to talk about the latest of views in Asia, where in particular we're going to be talking about the AI impact on the region, and also how the competition for capital will influence various economies in quite different ways. So really a lot to get our teeth into this week after what's been a very, very wild week for markets. Let's get stuck in. Well, it's been a week where clearly the US has been very much in focus, whether that's politics or data, recording this just after the US non-fampairos report came out. We've got Jeremy Schwartz, our chief US economist on the line. Jeremy, thank you for joining. Hey, Dom, great to be back. So look, we'll start with the politics, I guess. What were you taking? Clearly, the Democrats did a lot better than most people were expecting. A blue wave, blue army, a summer calling it. But from an economic perspective, what do you think this means? Yeah, so in the near term, I guess there wasn't too much distinction between sort of more modest Democrat gains, which were a lot of people's base case expectations, and this full-blown blue wave. So the near-term policy implications are really just gridlock with Trump still in the White House. We think it's very unlikely that Democrats and Republicans come together and pass any meaningful bipartisan legislation. And even with their gains this week, Democrats aren't in a position to be overriding Trump's videos. So we don't expect too much in terms of fiscal policy. It's interesting to think that Democrats might be well positioned for a kind of blue sweep after the 2028 presidential elections and have more of a free hand on the policy side there, particularly since they're within shouting distance of a 60 vote supermajority after the next Senate cycle. But that's kind of well in the future, kind of 2029 and beyond. You know, in terms of the kind of real policy implications, which I think are impacting markets now, the biggest factor wasn't the national races, but actually what happened at the state level, where a couple of kind of Democratic candidates for state governors performed, in particular, the victories in Texas and Georgia, went to two candidates who had really built a platform opposed to data centers and AI developments. You also saw a number of local referenda and a lot of local races show voter sentiment, so kind of pivoting away from AI development in favor of more regulation. And we think that some of those state houses can actually have a meaningful impact relatively soon. So there's discussions of a moratorium on new data center permits in Texas. I think a lot of regional governments who had might have been on the fence about how to approach AI regulation surely are reading the tea leaves on the national sentiment here. And so I think this just contributes to a growing body of evidence that you're likely to see not collapse in the data center build out, but maybe approaching an inflection point. Okay, well, I guess there's a long way for us to go in that in terms of how it all feeds into growth, et cetera, we can get to it in future episodes, but bringing it to sort of the very near term, we've just had the the labor market data and often I get to chat to you straight after this on this podcast. And it always seems to be the same story, pretty resilient US labor market. Is today's dates a more of the same? Yeah, I think it's more of the same, but there are starting to be some ripple effects of going from resilience to something more like outright strength or overheating. So just start with the top line numbers. Job gains did rebound to 165K in October, and that brings the three month average up to 137K. And you have good breath of employment across sectors with large contributions from some of the bigger service industries. Now again, that sort of looks like more of the same what we've been seeing recently. You know, you had to tick down on the unemployment rate to 4.1%, but again, that was just relatively small, it went from just rounding up to just rounding town. I think it's when you dig one detail level down where you start to see something which might begin to get more concerning for the Fed, which is that cyclical sectors are starting to show some tentative signs of overheating. So employment growth was actually relatively mixed this month, but if you look at average early earnings, there was a pretty sharp acceleration for construction and manufacturing. And it wasn't in the NFP print, but if you looked at the Joltz data earlier in the week, we saw job openings as well as quits rates, gaining momentum for the construction sector as well. So again, for a while now, you've had a strong cyclical domain, strong CAPEX growth, data centers are a piece of that, but also a more plain vanilla business investment spending has been quite strong as well. That hasn't really affected the labor market yet, but I'd say if you look over the past couple of months of data, there are some tentative signs that you're going from more of a Goldilocks resilience, but not overheating labor market to maybe something where the Fed needs to start worrying about upside risks to the medium term inflation outlook. That's really interesting, actually, given the sort of slow down we're seeing on the AI side, on the one out, or certainly reports of it, and fears about it, but on the other side that the broadening out of the growth story particularly in terms of employment. So that's definitely something we need to kind of keep an eye on, I guess, from a market perspective. The other angle obviously with all this is then how does it feed into inflation? We've got the CPI print coming out next week. Are we expecting any signs of inflation coming through there? Or is it still well too early? Yeah, so actually we're expecting a little bit of relief for the October inflation data. So we think, of course, CPI likely slowed to 0.126 percent month on month following that large upside surprise of 34 basis points since September. So in particular, we're seeing some softness in use vehicle prices as well as some cooling in some of the inflation spillovers from AI sensitive sectors. So those made a large positive contribution in September, and it's not as if they're going back to contributing deflation, but at least you're not getting signs of accelerating inflation pressure there. Meanwhile, super core services, we think some noisy components slowed, and there was an unusual spike in rent inflation in the last month's inflation report, which we think should unwind this time around. So overall, a little bit of relief, we think a lot of those drivers of the weaker CPI aren't going to pass through into PCE. So there you're still looking at a 28/21 basis point reading. And from the Fed's perspective, that's still above a 2% annualized pace, but at the very least it does still look like the realized inflation numbers are cooling. So we think that the combination of the labor and inflation data here certainly keeps a December hike, the strong presumption. I think there's a very high hurdle for them not to go after the pause in October, but I think there's still kind of more of a debate about the terminal rates within the committee and how much they potentially need to continue hiking through next year. Our expectation from here is it is one and done. We think that they are going to focus on that realized inflation momentum coming down, but the risks are very skewed to the upside. You have a lot of supposedly one-off drivers of inflation pressure. They seem to keep happening, and now if you do kind of get some continuation in this momentum for wage growth, at that point realized inflation between two and a half to three percent probably doesn't cut it, and there I think you realize that this is the persistent problem in your behind the curve. Fantastic, really interesting Jeremy. Thanks a lot for all of that detail. And as always, we look forward to having you on next time around. Thanks a lot. Yeah, thank you. Well, we're going to go to the UK now and we're actually recording this on Thursday in the aftermath of the Bank of England's decision to hike rates. We've got Josie Anderson from our UK and European economics team with us, Josie. Thanks, Zéffa, for coming on the show. I mentioned there obviously the BUE Hiked Rates. Do you want to give us a little bit more colour about what happened? And I guess maybe more importantly what the outlook is going forward now? Yeah, thanks, Roman. Thanks so much for having me on the podcast. So the Bank of England Hiked Rates by 25 basis point today. That is the first hike since 2023, but it was widely expected. We expected that. It was basically fully priced in by market. So I suppose the move itself in itself wasn't that surprising, but it was more hawkish than we and I think probably most others were expecting in that every member of the Nine Strong Committee voted for a hike, and even one actually wanted a bigger hike, a 50 basis point hike. So that was the big surprise today. And also the Bank's inflation forecast was revised up quite sharply. This was an inflation report we only get for a year. And it now peaks at nearly 5% next year. So I think that forecast kind of feeds into the bank's reasoning to hike rates. And of course the big story is energy and the Iran war and the bank has been able to kind of push off this hike this year. It's been saying because it went into this year with a fairly restrictive policy rate. It was planning to cut it and it didn't cut it. So that's how it's managed to wait for this long before hiking its policy rates. But now with energy having been high for persistently long, it's starting to get concerned about second round effects as a result of that even though it hasn't started to see evidence of them necessarily. Inflation being this high for this long means that they think they're pretty likely and therefore you need to raise rates. Now in terms of what we think for the future, we already had one more hike in our forecast in February. The risks are often today I think clearly that there'll be another hike or possibly more after that. It does really all depend on energy though of course. And for now we just maintain our forecast of one more hike in February. So that would be to a 4.25% policy rates. But yeah. Inflation second round effects data. So that's on things like wage growth, wage negotiations heading into the start of next year will be very important to watch alongside of course energy prices. Thanks. You're very very clear indeed. I mean I think it was stand out to me at least just how focused a lot of the committee are on energy prices and the developments there and clearly what's happened in the last few days as we record this with oil dropping below $100 a barrel would be a positive in terms of you know not maybe needing to hike and having lower inflation but I think the bank made it pretty clear they'd want to see a lot more of that before they could feel comfortable. I guess the other hawkish thing you reference there as well was on the growth side and we do get I think some growth numbers next week and also just some references in the press conference to the AI impact on growth which is quite interesting because in some ways the AI theme in the US seems to be rolling over quite aggressively as we record this but you know what is the UK's activity outlook at the moment you know is growth it's obviously been pretty strong how much of that is AI is it just general resilience and what should we take on sort of the growth and activity outlook at the moment. Yeah so GDP growth this year in the UK has been remarkably resilience over the last few years we've kind of seen it tailing off towards the end of the year but we already have two months of Q3 data that we're getting out next week and it looks likely that we'll see around a 0.6.7 percent quarter and quarter growth rate the Bank of England's forecasting 0.7 and the Bank of England does say it thinks that at least a good portion of that is down to AI investments and businesses investing more in their AI capacity and so this is kind of a positive story that we're seeing in the UK this year although of course the flip side of that is that a stronger economy and more resilient economy does give more potential for second-round inflation effects and so that's potentially another reason to hike for the Bank of England but in terms of the growth outlook it is quite a positive story and as I said the months of data we've already got for the Q3 data coming out next week do suggested it will be another strong quarter. Okay fantastic well just moving moving on a little bit we also had central bank decisions this week in Scandinavia both nauseous bank and rick's bank delivered rate hikes was there anything that stood out for you from from those central bank meetings. So kind of similar to the UK we had the first hike from the rick's bank this week and it raised its policy rate to 2 percent from 1.75 percent as similar to the UK as well that was that was widely expected but actually the surprise from Sweden this week was in the inflation data we got out the next day. Inflation in Sweden has been soft this past year partly just because of tax cuts which mean that it mechanically lowers inflation but when you look at the excluding energy measure that the rick's bank looks at it was just 0.1 percent year on year in the data that kind of surprised consensus to the downside that was looking for 0.5 percent year on year. So that does call into question if if there'll be more rate hikes from the rick's bank given that inflation is so low in that country we're actually forecasting two more two more rate hikes in February and May next year as we do think there are in quite notable upside risks to inflation still you know partly there will be a mechanical increase in inflation next year the kind of the flip side of the mechanical lowering this year but also Sweden is exposed to higher energy prices and similar to the UK as well actually it's had a fairly resilient economy this year that exposes it to second round inflation effects. So we are still expecting rate hikes there but the inflation data is certainly one to watch and there was the bigger surprise this week than the rick's bank itself and then we also had the Norgesbank decision that was on hold as was widely expected. Norgesbank has already hiked rates twice this year and so another hike at this meeting was unlikely and also the policy rate is fairly restrictive there at four and a half percent so we're not expecting any further rate hikes there. Brilliant thanks very much interesting to see some of those comparisons between say rick's bank and the bank of England I think from a from a currency perspective at least we're not quite as positive on the on the sterling at the start of this rate hike cycle compared to the stocky we're actually in the Swedish Krona has a fair bit of scope to correct it's relative under valuation actually as the rate hike cycle does start but as you pointed out that inflation data did just make that trade a little bit a little bit trickier in the short term but always good to chat Josie thanks a lot for coming on and we'll speak to you soon. Thanks a lot. Well let's move over to Asian now where I'm joined by Sunolvama our chief economist for Asia extra-pan Sunol thank you very much for coming on um let there's not necessarily a huge amount of data coming out to talk about in terms of the week ahead but you did just publish your latest economic monthly which is titled Capital Wars which I thought was a really interesting title so you just tell our listeners what you're looking at in this piece and what your sort of key conclusions are. Yeah sure hi Dom so I guess the central message is that global competition for capital is heating up so we're seeing rising investment demand from you know AIKpex large fiscal deficit defense and industrial policy agenda and this is happening at a time when the global savings pool has actually become a lot more discerning and to some extent driven by geopolitics and not always returns so we think the net effect of this is essentially more volatility in capital flows going forward fragmentation of savings higher neutral rates and for Asia therefore a wider gap between the capital surplus and the capital deficit economies so the capital surplus economies in Asia so Korea Taiwan Japan China Singapore they actually have an advantage because the rest of the world will be competing to attract their surplus you know as we are seeing with some of the US investment deals these countries can actually increase the home bias mandate for their pension funds for instance but the capital deficit economy is in Asia so India Indonesia and Philippines we think this environment means that their sustainable current account deficit will be much lower the central banks will face more frequent trade-offs between growth and financial stability risk so they will end up doing more of macro potential and capital flow management measures suppressing resident outflows incentives to attract more capital inflows etc so we think this is sort of a more structural shift in the regime and economies and policymakers will have to prepare for this coming period yeah I mean it's a really interesting theme actually so now we're seeing in developed markets on FX as well and you know things like the Japan easy and you're even the euro where you've got these kind of build up of savings potentially providing a bit more support going forward but as things stand it's pretty it's pretty choppy in the short term you know talking about that short term outlook as well you know how much do you think this recent AI sell-off etc really exacerbates the theme you're just talking about how much does it impact your your regional economies in different ways so AI has actually been a very important driver of growth in Asia in the last two years but I do think it's important to distinguish between the AI stock market sell-off versus [BLANK_AUDIO] AIKpex and whether it is going to slow down as a result of this stock market sell-off. So in Asia, actually, the stock market wealth effects have been an important consumption driver in South Korea. But for rest of Asia, actually, it's been more the real economy effect. So exports of tech or investment and tech and related equipment, that's been a bigger driver of growth. So right now, what we are seeing is, of course, you know, a significant sell-off in AI stocks. But we don't think there are signs yet that AIKpex is going to be cut in 27 and beyond. In fact, when we look at memory chip prices, the remain elevated GPU rental rates are going up. On the ground feedback shows that the industry remains very supply-constrained. In fact, the order book of Asian hardware manufacturers is booked all the way through 2027 and the memory players, they have more long-term agreements in this cycle. So I mean, if this stock market sell-off continues, then yes, financial conditions will tighten and it does add some downside risk to growth. And I think in particular, for Korea, on the consumption side, it could be a negative. India, which is seen as an AI hedge, you know, can benefit from flows actually reversing more on the positive side. But if the AIKpex holds up next year, which is our base case, then we think exports and investment demand should continue to do well in the region. So I mean, that's a dumb. I mean, things are still evolving as we speak. And this is quite central to our outlook, so watching the space very closely. Yeah, and I'm absolutely agree. It's very very much in flux, as we speak. I think the other interesting part of this, and you may be touched on a point there, you know, around the different impact of on growth, I've noticed in Asia being a bit of a distant observer, some sort of slightly different monetary policy reaction functions, whether it's across New Zealand versus Australia, whether it's Malaysia versus Philippines, for example, some sort of different responses in the short term. Is that something you expect to continue a bit more divergence on monetary policy? I mean, you're right. And in fact, when they run war had broken out, we had one of the themes we had pushed was the divergence across the region. So you're absolutely spot on. I mean, there is divergence. And we think this divergence is in turn a function of a few more fundamental factors. So the exposure to food and energy prices, the role of fiscal policy in mitigating some of the inflation risk. Are we seeing inflation generalization in each economy or not? What is the risk on the currency and the balance of payment front? The benefits from AI cycle or not, strength in domestic demand. And most importantly, you know, the central bank reaction function, which differs across countries. So the doves in the region have been Thailand, Malaysia, China, and even Taiwan, which has been one of the biggest beneficiaries from the AI cycle. The hawks, the hawkish central banks have been Philippines and South Korea, India, Indonesia somewhere in the middle. And as we look forward, I do think this divergence is likely to continue. So for Philippines, which has already been one of the most aggressive rate hikers in Asia, we think the BSP is going to deliver another 75 basis point in cumulative rate hikes, including a 50 basis point hike in December versus Bank of Thailand, where despite the higher headline inflation this week, we are expecting Bank of Thailand to remain on hold through 2027. And China, where we think there could in fact be some policy easing. So divergence will remain a team going forward as well. Brilliant. Thanks so now. I'm really interested to speak to you as always. Lots going on in your space as well as across markets. So I'm looking forward to seeing how that all plays out. Have a great weekend. You do. Thanks a lot, Don. Well, that's it for the week ahead. 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