Please note: AI generated transcript.
Text on screen: Global macro conditions today. Adam Whiteley, Head of Global Credit
Hi, I'm Adam Whiteley, Head of Global Credit, and in my session we're going to explore some key themes in the global macro environment.
The environment today continues to be characterized by unprecedented uncertainty and central to that uncertainty is a big disconnect that's appeared between the US activity or growth data and the US labor market.
And the most likely explanation for that disconnect is the role of ai.
Time will tell if AI proves to be a bubble, but the story for today is the enormous capital expenditure being spent to enable the AI revolution.
On the left hand chart. Here we can see the CapEx plans from the so-called hyperscalers, the Metas or the Googles of the world. And these are projected to accelerate to 2% of GDP per annum cumulatively giving an enormous tailwind for growth and may paper over some of the broader cracks in the US and the global economy.
In contrast, the.com bubble where speculative spending was being undertaken by companies with weak balance sheets that AI spending is being undertaken by companies with exceptionally strong balance sheets. And in fact that balance sheet and business strength is currently being echoed across the corporate sector as we can see from the right hand charts where profit margins are at multi-decade highs.
If we turn to the other side of the disconnect and look now at the US labor markets, we can see from the left hand charts that actually there were far fewer jobs than were previously thought. Within that US labor market, the data releases have been actually revised downwards, shown here on the left chart between the difference in the gray and the green shading. And if we were to then look on a timer series for the right hand chart, we can see that actually job growth in the US has slowed to almost nothing or put another way, the US job market is very close to being in contraction.
Why is this worth watching? Well, it's historically been very rare for jobs market to be negative at the same time as GDP or growth is positive and the jobs market is much like an oil tanker. Once it starts moving, it becomes very difficult for it to change course.
What's worse is actually we've lost our window into the job market because of the US government shut down. The agencies that would normally be producing these data sets are no longer doing so. So we're flying blind markets continues to be driven by ongoing economic policy and political uncertainty, and whilst President Trump may be the disruptor in chief, these are all global risks and we'll pick up on these themes in the slides that follow, whether that's trade, where we all know about the tariff changes that we've seen over the last year or so. The key question here will be who bears the cost?
What's the impact on growth? What's the impact on inflation For immigration, we're seeing a slowing of immigration in developed economies and this has changed the supply of labor such that we've now got a much tighter labor market and potentially we've got a different picture of what's going on to what we would historically have assumed on fiscal policy. There's very much a difference between willingness and ability to spend on fiscal across different countries. Germany has both willingness and ability.
UK and France arguably less ability but still has the will and in the US it's much more around debt sustainability that's driving the investor narrative.
And finally we've got geopolitics. Investors are having to worry about polarized electorates, warring nuclear powers and question marks over the independence of some certain very important institutions.
And this is why it's even more strange in that despite all this uncertainty, we're basically priced for no surprises when it comes to the risk assets of the left hand chart here showing global investment grade credit spreads or the difference in borrowing cost for a corporate compared to a government. And here credit spreads, uh, 25 year lows on the right hand charts looking at a measure of equity market valuations here using price earnings ratios. It's the same story. Valuations are close to 25 or 30 year highs. And if we were to look under the hood, actually the leadership of the US equity and indeed global equity market is incredibly narrow led by that tech and AI sector.
Turning now to the tariffs where the left hand chart is showing that the policy and certainty regarding trade policy is absolutely past the highs, but the expected US effective tariff rate is still going to be the highest since World War ii.
Why does this matter? Somebody has to pay for this, whether it's the exporter, the import, or the consumer that pushes up prices, it pushes down profit margins and this makes beyond that planning incredibly difficult when the a hundred years of global supply chains are being rewritten and being rewritten on the hop.
It's entirely possible that we've not seen the full effects of the tariff changes announced this year because of a lot of front loading that would've occurred earlier in the year to try and get in front of the tariffs and the consequent price increases Turning to fiscal policy where US fiscal policy continues to be in the limelight with the passing of the flagship one big beautiful bill, its cements budget deficits in the US at five to 6% for the coming years and that has some big implications for the debt pile. It's one big beautiful pile of debt where if we were to look at the area to the right hand side of the blue dash line on their own projections from the congressional budget office, it's entirely possible that US debt doubles over the next 25 years.
Somebody has to pay for that and it's also a reason why the tariffs are likely here to stay because they need extra revenue sources to help offset a lot of that spending.
And this beyond providing a impulse to growth com complicates the picture for the US Federal Reserve as their central bank because it is also providing upwards pressure on inflation.
Having said that, somebody has to pay for all of that debt. Someone has to give the borrowing to the US and its government agencies.
We're seeing some unintended consequences from the left chart here. It's less obvious that the Chinese are going to be continually sponsoring the US treasury market where we can see that their holdings have been coming down as they've been diversifying away into other geographies and other asset types.
And if you increase the supply of something then all else equal, you need to try and push down the price.
Price down, yield up is one way of doing it. Or alternatively, you can try and make your assets more attractive to foreigners and that's where the currency comes into play.
And what we can see from the right hand chart is that actually the dollar the US currency has been depreciating and is now back in line with its long run averages making US treasuries more attractive to foreigners on a currency basis.
A lot of the resilience in the US economy is undoubtedly coming through from the US consumer and by extension that's providing resilience to the global economy whilst the cost of living's increased. What is occurring is a very positive wealth effect from rallying stock markets increasing confidence in the consumer and that's giving them greater ability and comfort when it comes to their spending decisions.
But from the right hand chart here, we can see that that wealth effect is not uniform. It's very much concentrated in the high income earn, the lower income cohorts are really struggling.
And this then brings us back to that AI bubble where if it's the AI mania that's driving the stock market, then if we get any undermining of that AI story, AI valuations come off the boil markets go down the wealth effect on wines that would take away that resilient consumer very quickly.
Turning to Europe where there are some common dynamics, but equally there's some different ones here we've seen a dramatic change in fiscal mindset where Trump arguably has made Europe great again by catalyzing and urgency to re-arm and spend on defense.
At the same time as Germany has announced it wants to spend on infrastructure in a way that it's not done for decades.
Fiscal spending here will give that tailwind to growth as well as providing downside protection.
But the beauty of Europe or arguably the Achilles heel is that it's a country block and that means that not everyone will be able to follow Germany.
They have to adhere to the fiscal rules within the Euro zone fiscal pact including the EDP or excessive deficit procedure.
And what this chart is showing is that countries in a very different position over on the right hand side, the tables really turned where Greece having endured a very difficult sovereign crisis in 20 10, 20 11 is now actually in probably the best place of all of the Eurozone countries. And on the left hand side, the weak links of France and Belgium where they need to make some very difficult choices in Europe, there really isn't an inflation problem. The left hand chart here is showing that inflation is pretty much back to the European central bank's targets and tariffs because it's only against one trading partner are likely to be disinflationary because tariff on price up that reduces demand offsetting.
Some of this is the fiscal boost coming from Germany and any follow the leader where the right hand chart is showing the before and after effect of removing the German debt break that was previously constraining their spending ability.
And if we look at the difference from the dark and the light green lines, the numbers here are 1% per annum and that's just for Germany. So if we extrapolate that over the rest of the Euro zone, these can be material numbers driving growth in Europe in a way that we've not seen for some time bringing it together in terms of policy rate expectations for central banks, it's highly likely that cash rates today will be gone tomorrow.
The lines on the chart here are market expectations for where we would expect central bank policy rates to be over the coming months. And what we can see very clearly is that the market has been through time bringing down its policy rate expectations and in the future we should expect lower policy rates where for the US our forecast a year ahead are for closer to 3%.
For Euro zone it's more like 2% and for the UK something like 3.8% for a policy rate.
But this isn't central banks that are trying to create a stimulative policy setting. It's is simply them removing the current level of restrictive policy and getting to something that's closer to neutral, further out the bond curve. If we look at yield curve shapes or the difference in borrowing costs between 10 year government bonds and 30 year government bonds, there's some interesting dynamics at play here too.
What stands out is in the orange line for Japan, their first year government bonds have got materially more expensive for them to finance than their tenure.
It's probably no coincidence that Japan is the developed market economy that's got the most debt and therefore if we have got concerns on ongoing fiscal looseness and debt sustainability, they would feel it the most.
But here we think there's an opportunity, we think that 30 million bonds are attractive relative to 10 year not least because Japan is one of the only central banks on the planet that's likely to be putting up its policy rates in the uk in the green. We think that here too, there's value in long dated government bonds relative to 10 year. But in the US and Europe, we think the space for yield curve to steepen or long dated bonds to underperform, it's that long dated bond that's gonna be vulnerable to those ongoing fiscal concerns, whereas the shorter dated bonds will be sensitive to the interest rate cuts we expect to be coming through.
Summarizing the economics, our central case is that we would expect positive but below trend growth across regions for the US, Europe and the UK respectively, our 2026 growth forecasts of one and a half, 1.1 and 1.1% respectively on inflation, we would expect it to continue coming back to central bank targets, albeit it's a more bumpy path, more murky path in places like the US and the uk and for the US we would expect it to be peaking out probably in the first quarter of next year principally because of the tariff impact.
But our conviction in that central case for both growth and inflation is lower than we would like. The alternative scenarios that we're thinking about typically involve less growth and more inflation.
Against that backdrop, we're expecting the central banks to be easing and when we bring it together for our views on fixed income markets, thinking about the rates and the credits asset classes separately for our directional views on the duration in the top left quadrants, we do think there is a modest amount of value within government bonds forecasting one year ahead at the 10 year point for the us, UK and Germany yields of 4%, 4.8% and 2.8% respectively.
Cross markets. We think there's a lot of relative value opportunity where as much as we've got a global cycle, we've got different market pricing, different central bank reaction functions and different economic sensitivities that therefore leads us to favor places like Australia and Canada and selectively Latin American governments on a relative basis compared to the US yield curve is now more nuanced, expecting steeper yield curves in the US and Europe, but flatter yield curves in Japan and the UK and in inflation too. There's some interesting dynamics here. We find it very strange that for long dated inflation expectations, the US is priced the same as Europe.
We think that structurally you're likely to see more inflation in the US compared to Europe, turning to credit in our central case of positive but below trend growth, falling inflation, easier monetary policy, that should be a supportive environment for credit.
But those alternative scenarios of less growth and more inflation would certainly be more challenging. And against that backdrop, valuations are on the more expensive side of history and whilst we can justify them in our central case, there's no margin for error and therefore our medium term view on credit is neutral and within our relative value decisions, firstly, an asset allocation or macro credit relative value level, we think there's better value in Europe compared to the us, but we're cautious on high yield where in an environment of higher costs of capital and less growth and therefore more earnings pressure, high yield will fill up.
First. For sector strategy, we're defensive for the ongoing economic uncertainty. There's very limited cyclical risk. Premium and within security selection, picking the winners and avoiding the losers. Once we've got more tariff clarity, we would expect m and a to really pick up because we've got a pro business US administration that particularly wants to deregulate.
Thanks for your interest. That's the end of my session. If you've got any questions, please reach out to your insight representative.
