WEBVTT 1 00:00:10.041 --> 00:00:22.567 Hello, I'm Aline Van Dyne in New York, and welcome to the Macro Brief from HSBC Global Investment Research, our weekly podcast that looks at the key drivers of financial markets around the world. 2 00:00:23.188 --> 00:00:26.669 Now, it won't be hard to guess what we're talking about today. 3 00:00:27.170 --> 00:00:35.214 Historic U.S. midterm elections have resulted in big gains for the Democrats and losses for Donald Trump's Republican Party. 4 00:00:35.734 --> 00:00:39.276 So we're facing divided government for the next two years. 5 00:00:39.296 --> 00:00:39.516 Hello. 6 00:00:39.916 --> 00:00:41.896 What does it mean for markets and investors? 7 00:00:42.316 --> 00:00:45.977 We'll be talking about fiscal issues and AI regulation. 8 00:00:46.497 --> 00:00:50.298 And to do that, I'm joined by Ryan Wang, our US economist. 9 00:00:50.678 --> 00:00:51.098 Hi, Eileen. 10 00:00:51.438 --> 00:00:54.459 Deiraj Narula, our US rate strategist. 11 00:00:54.479 --> 00:00:55.019 Good afternoon. 12 00:00:55.379 --> 00:00:58.600 And Alistair Pinder, our global equity strategist. 13 00:00:58.620 --> 00:00:59.140 Thanks for having me. 14 00:00:59.280 --> 00:01:00.320 Welcome, team. 15 00:01:00.820 --> 00:01:03.921 As always, let's start with a quick recap of the headlines. 16 00:01:04.021 --> 00:01:05.661 Ryan, talk us through the results. 17 00:01:06.285 --> 00:01:06.945 Thank you, Aline. 18 00:01:07.145 --> 00:01:17.349 Well, as you highlighted, Democrats have secured a majority in both the House of Representatives and the Senate, the new Congress that will take office in January of 2027. 19 00:01:17.849 --> 00:01:22.111 And I think what was particularly striking for financial markets in a way was the margin of victory. 20 00:01:22.711 --> 00:01:32.917 We don't have all of the results just yet, but it appears that Democrats could easily hold 250 or more seats in the new House and as many as 56 seats in the new Senate. 21 00:01:33.377 --> 00:01:38.240 And those margins are larger than markets were thinking one or two months ago. 22 00:01:38.740 --> 00:01:44.844 And even the day before, because it wasn't even clear if the Democrats could gain control of the Senate. 23 00:01:45.236 --> 00:01:46.297 I mean, that's absolutely right. 24 00:01:46.317 --> 00:01:59.884 There were six key Senate races that were most in focus, and it currently appears that Democrats will win all six and potentially even one or two more that were really not considered to be all that competitive, leading much more in a Republican direction. 25 00:01:59.924 --> 00:02:03.066 So certainly we can characterize it as a big blue wave. 26 00:02:03.703 --> 00:02:14.631 So, of course, we could talk for hours about what this means for the outlook for both the Republicans and the Democrats, especially in the run up to the next presidential elections. 27 00:02:14.891 --> 00:02:24.998 But instead, we're just going to focus on some of the policy impacts, specifically fiscal concerns keep coming up and AI regulation. 28 00:02:25.558 --> 00:02:30.081 Ryan, let's start with the fiscal piece and then we'll bring in Deiraj and Alistair. 29 00:02:30.682 --> 00:02:32.003 What's on your radar there? 30 00:02:32.550 --> 00:02:43.739 Well, if we think about the fiscal outlook in the United States in broad terms following these midterms, I guess what I would say is that there is going to be a type of policy shift in the next two years. 31 00:02:44.379 --> 00:02:50.744 And, you know, very clearly in the last two years, really fiscal policy has been constructed by Republicans only. 32 00:02:50.844 --> 00:03:00.412 You know, and the biggest symbol of that was the one big beautiful bill act, which was passed only with Republican support through this process known as budget reconciliation. 33 00:03:00.432 --> 00:03:01.032 Right. 34 00:03:01.112 --> 00:03:03.513 But beginning in 2027, that will have to change. 35 00:03:03.813 --> 00:03:08.875 Any legislation, including fiscal legislation, will have to be really a compromise between Republicans and Democrats. 36 00:03:09.595 --> 00:03:11.375 And the Republican part is still very important. 37 00:03:11.596 --> 00:03:17.778 Of course, President Donald Trump will retain veto authority over really any legislation. 38 00:03:17.898 --> 00:03:19.858 So that is really going to be the difference. 39 00:03:20.258 --> 00:03:23.580 And there's one deadline I'm focused on that even is happening this December. 40 00:03:23.800 --> 00:03:24.520 On December the 11th. 41 00:03:25.280 --> 00:03:29.743 The current Congress will actually – they must act to avoid a government shutdown. 42 00:03:30.123 --> 00:03:31.324 Of course, they can extend things. 43 00:03:32.004 --> 00:03:35.146 They could pass a so-called continuing resolution to push that deadline into next year. 44 00:03:35.426 --> 00:03:37.607 But one way or the other, something will have to be done. 45 00:03:37.627 --> 00:03:44.011 That could be an early signal about how well this Congress or how well Congress will work together in the year ahead. 46 00:03:44.431 --> 00:03:48.554 And Dheeraj, any market reaction to these types of concerns? 47 00:03:48.574 --> 00:03:48.674 Yes. 48 00:03:49.129 --> 00:04:04.209 Well, I think on the fiscal front, if we think about an outlook where you look at the next two years and think there's less scope for something as big in terms of fiscal expansion as the big, beautiful bill or even under previous administrations, not having that potential upside down. 49 00:04:04.629 --> 00:04:09.032 scope for upside surprise to deficits is something that you would expect the Treasury market to like. 50 00:04:09.452 --> 00:04:16.936 And in fact, the idea that there could be less room for upside surprises in the amount the Treasury has to issue is something that investors would appreciate. 51 00:04:17.117 --> 00:04:27.803 However, I would say in terms of the market's reaction, we've already seen the market in the past few months come to this baseline expectation that the Democrats would at least take the House of Representatives 52 00:04:28.484 --> 00:04:33.209 And in doing so, create this sort of divided government outcome that Ryan was talking about. 53 00:04:33.229 --> 00:04:37.675 So sort of that aspect of market pricing had already played out in our view. 54 00:04:38.156 --> 00:04:43.102 But overnight, we did see treasury yields across the curve come down quite considerably. 55 00:04:43.122 --> 00:04:44.083 And rather than being... 56 00:04:44.323 --> 00:04:45.463 primarily a fiscal story. 57 00:04:45.503 --> 00:04:48.224 And this is where I think I'd love to hear what Alistair has to say. 58 00:04:48.564 --> 00:04:56.725 I think it does also come down to the ramifications for the AI story in the U.S. and perhaps maybe not even only at a federal level or kind of a Congress level. 59 00:04:56.765 --> 00:04:59.826 We did have, of course, gubernatorial elections overnight. 60 00:05:00.546 --> 00:05:07.687 Notably, the governor of Texas race was resulted in favor of the Democrat Party for the first time in decades. 61 00:05:07.707 --> 00:05:11.648 And that does have big implications for the build out of data centers, et cetera. 62 00:05:11.688 --> 00:05:11.768 And 63 00:05:12.208 --> 00:05:21.122 From the treasury market's reaction, at least, my read would be that we do have some sense of perhaps risk-off sentiment and that benefits the safe haven aspect of treasuries. 64 00:05:21.483 --> 00:05:24.187 But I'm curious how the sort of equity story plays in here. 65 00:05:24.712 --> 00:05:26.593 Yeah, I mean, it's a good question. 66 00:05:26.613 --> 00:05:30.114 I think from the AI side, there's multiple angles that people are focusing on. 67 00:05:30.214 --> 00:05:33.055 One is broad AI regulation. 68 00:05:33.335 --> 00:05:45.460 I think that angle is kind of unlikely, purely from the perspective of federal regulation on AI, you know, clamping down on AI models and putting regulation around that. 69 00:05:45.900 --> 00:05:49.544 does need basically, you know, approval from the president as well. 70 00:05:49.604 --> 00:05:53.868 And there's a large chance that I think that any kind of regulation that gets pushed could get vetoed. 71 00:05:54.288 --> 00:05:59.333 The more, I guess, capable thing that could get pushed is around the regulation on data centers. 72 00:05:59.373 --> 00:06:03.297 Now, again, do I think there's going to be a federal restriction on data center build out? 73 00:06:03.357 --> 00:06:03.998 Definitely not. 74 00:06:04.378 --> 00:06:07.460 But at the state and local level, it is a much bigger risk. 75 00:06:07.520 --> 00:06:08.541 And you mentioned Texas. 76 00:06:09.041 --> 00:06:17.167 In Texas, around 30% of the nationwide data center capacity coming online by 2028 just comes from that state alone. 77 00:06:17.707 --> 00:06:26.834 And so the new governor has basically said that they want to have an immediate moratorium, essentially putting a pause to new development on that data center front. 78 00:06:27.034 --> 00:06:30.176 And that, I think, could be a bit of a challenge for that AI theme. 79 00:06:30.525 --> 00:06:50.002 And just to give our listeners the context, data center buildouts and increasing opposition from communities to expansion without perhaps some clearer guardrails was a massive campaign issue across the country. 80 00:06:50.022 --> 00:06:50.122 Yeah. 81 00:06:50.612 --> 00:06:50.832 Yeah. 82 00:06:51.153 --> 00:07:00.602 And even if you look at what the Democratic candidates, say, in Texas were campaigning on, again, the pushback was they didn't want to have high electricity prices. 83 00:07:01.322 --> 00:07:05.446 They were worried about actually electricity shortages elsewhere in the state. 84 00:07:05.987 --> 00:07:11.552 And so there is conceivably a middle ground here, which is that the hyperscalers could offer to pay. 85 00:07:12.913 --> 00:07:14.554 some of the electricity build. 86 00:07:14.935 --> 00:07:20.138 I think there is this kind of, I guess, extremist view that you could say, well, data centers are going to be stopped altogether. 87 00:07:20.218 --> 00:07:21.359 I think that's very unlikely. 88 00:07:21.379 --> 00:07:24.381 I think there's clearly going to be a middle ground that gets found in that. 89 00:07:24.762 --> 00:07:32.907 But I think there's definitely, you know, the idea that data center construction could slow and that some of the construction in 2027 and 2028 slips into 2028 to 2030 is definitely conceivable. 90 00:07:36.650 --> 00:07:46.063 The other thing that's just worth bearing in mind, though, is that, you know, we mentioned this number, the $1 trillion of CapEx that gets spent by the hyperscalers every year and going into 2027 and 2028. 91 00:07:46.484 --> 00:07:50.810 The remarkable thing about that, of that $1 trillion, 70% is spent on GPUs, memories. 92 00:07:53.033 --> 00:07:56.835 It's nothing to even do with the actual physical construction of that data center. 93 00:07:57.255 --> 00:08:09.420 And there's such shortage in that sort of, you know, semiconductor memory space that conceivably, again, you could still see the hyperscalers spend to get that equipment so that they can stockpile it, put it in inventory. 94 00:08:09.840 --> 00:08:12.601 And it doesn't really derail that spending too much altogether. 95 00:08:12.888 --> 00:08:18.271 I was going to follow up, Alistair, just to be clear about why this matters so much. 96 00:08:18.492 --> 00:08:25.116 So, of course, the spend, the CapEx spend, has been fueling some of the rally. 97 00:08:25.476 --> 00:08:30.279 The expectations of growth has been fueling the rally in stock markets. 98 00:08:30.960 --> 00:08:34.562 So it's about whether this growth slows. 99 00:08:34.802 --> 00:08:35.983 Is that the key question? 100 00:08:37.103 --> 00:08:38.744 Yes, does the AI growth slow? 101 00:08:38.764 --> 00:08:41.625 A, do we have enough compute? 102 00:08:41.765 --> 00:08:47.167 I mean, these data centers basically are providing compute for all of these models to be run. 103 00:08:47.527 --> 00:08:51.729 Do we have enough compute to satisfy all the demand for AI going forward? 104 00:08:52.089 --> 00:09:00.552 And if we have bottlenecks, does the monetization, both from the cloud side, but also from the AI models themselves, start to hit headwinds? 105 00:09:01.372 --> 00:09:05.453 One of the biggest problems, I think, for the AI story is that they're spending all of this money now. 106 00:09:05.893 --> 00:09:07.674 They need to monetize this soon. 107 00:09:07.694 --> 00:09:09.714 They've got this huge negative free cash flow. 108 00:09:09.874 --> 00:09:11.715 That's why they're going borrowing in the debt markets. 109 00:09:12.075 --> 00:09:18.937 And so any delays to that monetization, because they can't build out this capacity, starts to put a lot of issues on some of these companies. 110 00:09:19.393 --> 00:09:27.198 So I think from the treasury market perspective, you raise a good point, Alistair, in the sense that maybe it's not the entire story that's in anyone's base case really collapsing. 111 00:09:27.238 --> 00:09:43.148 But the fact that we're asking more questions around the timeline, whether some of these things are slowing or whether investors should be more cautious, I think brings up this sort of other sided tail risk to the global macro picture, because for so long in the treasury markets, it's really all been about inflation and oil. 112 00:09:43.188 --> 00:09:47.291 And if you look at, for example, 10 year treasury yields for a lot of the last six to eight months. 113 00:09:47.311 --> 00:09:47.471 Yeah. 114 00:09:47.631 --> 00:09:50.054 They've been very, very closely associated with oil moves. 115 00:09:50.354 --> 00:09:59.083 But in the last couple of weeks, if you look at, say, 10-year yields versus the NASDAQ or a basket of tech stocks, they've actually become suddenly very, very closely associated. 116 00:09:59.103 --> 00:10:05.469 And I think that has reflected this idea that we've now gotten more of attention in macro forces. 117 00:10:05.790 --> 00:10:08.913 And I think that moving forwards, in some ways, that could actually be. 118 00:10:09.233 --> 00:10:22.205 somewhat of a relief in the treasury market just because we've got both sides of tension now, potentially limiting just how much yields may surge, for example, because it was only a couple of weeks ago where we were asking, where will the sell-off in treasuries be contained? 119 00:10:22.245 --> 00:10:24.547 How high can 10-year, 30-year yields go? 120 00:10:24.587 --> 00:10:26.569 And today we're considerably off that. 121 00:10:26.849 --> 00:10:30.973 And I do think some of the ramifications from this AI story are a contributing factor. 122 00:10:31.719 --> 00:10:34.702 Ryan, let's pivot back to the fundamentals. 123 00:10:35.363 --> 00:10:47.557 Just give us a recap of what's next in terms of this story about U.S. inflation, energy prices, and of course, what the Fed will do. 124 00:10:48.097 --> 00:10:52.741 Yeah, well, I mean, I would just piggyback on everything that Alistair and D-Raj have just been talking about. 125 00:10:53.021 --> 00:10:56.243 Alistair talked about electricity prices, which are very salient. 126 00:10:56.263 --> 00:11:01.427 You know, they're not quite as visible as motor fuel prices, but they're still very, very important. 127 00:11:02.148 --> 00:11:08.353 And also the AI CapEx has even spilled over very clearly into consumer electronic prices. 128 00:11:08.413 --> 00:11:12.916 I mean, they're not the largest part of the consumer basket, but the prices are up and that makes a difference. 129 00:11:12.936 --> 00:11:14.577 It's a very visible signal as well. 130 00:11:15.698 --> 00:11:24.486 And the issue, as D. Raj highlighted, is really now that there's essentially risks in multiple directions, different scenarios with totally different implications for inflation. 131 00:11:24.886 --> 00:11:28.730 Because if we do have this big retrenchment, that should be disinflationary at some point. 132 00:11:29.090 --> 00:11:30.551 We know the Fed is focused on this. 133 00:11:30.932 --> 00:11:38.318 Actually, we know that the Fed will be having a field hearing for one of its task forces, the Productivity and Jobs Task Force, which is going to be focused on this. 134 00:11:38.378 --> 00:11:46.925 which is really primarily focused on AI from a different angle, from what will be the medium-term impacts on the labor market and on productivity growth. 135 00:11:47.025 --> 00:11:59.356 And we also know that Fed Chairman Kevin Warsh, for his own part, has expressed the view that, yes, okay, AI CapEx is essentially boosting inflation today, but the productivity benefits might be disinflationary in the future. 136 00:11:59.596 --> 00:12:00.137 So for us, 137 00:12:00.657 --> 00:12:01.437 It's all related. 138 00:12:01.858 --> 00:12:14.244 We retain our view that the Fed will only deliver one more 25-base point rate hike in December, following up on the 25-base points delivered in September and the so-called skip, I guess, at the October FOMC meeting. 139 00:12:14.524 --> 00:12:21.028 That's a little bit less than market pricing, which still is over the year ahead is pricing in at least another 50 basis points of increase. 140 00:12:21.388 --> 00:12:23.689 But it just shows that there's these conflicting factors. 141 00:12:23.709 --> 00:12:25.991 The official inflation data is still 3% or higher. 142 00:12:26.971 --> 00:12:31.352 But you do have these different things going on in financial markets that the Fed is trying to figure out. 143 00:12:31.832 --> 00:12:38.754 One final thing just to mention on the equity markets, because, you know, I think one of the surprising things was that today the S&P 500 is up 2%. 144 00:12:39.135 --> 00:12:47.197 So despite this narrative that the AI traders, you know, going to be under pressure, actually equities are rallying, you know, into this result. 145 00:12:47.217 --> 00:12:48.177 And I think there's two reasons. 146 00:12:48.657 --> 00:12:54.559 One is because I think heading into the midterms, there was a lot of uncertainty. 147 00:12:55.279 --> 00:13:07.305 And I actually think this midterm election could be seen as a clearing event, particularly that given afterwards, President Trump did mention the idea of collaborating with the Democrats. 148 00:13:07.345 --> 00:13:10.267 And that, I think, was something which steward the market concerns. 149 00:13:10.787 --> 00:13:14.449 The second thing also goes back down to some of President Trump's and also J.D. 150 00:13:14.489 --> 00:13:14.909 Vance's. 151 00:13:15.469 --> 00:13:22.234 comments around the Middle East, acknowledging that, you know, the war was one of the reasons for potentially their underperformance. 152 00:13:22.574 --> 00:13:27.738 And that has kind of driven some hopes that maybe, again, we might see push towards a ceasefire. 153 00:13:28.058 --> 00:13:33.162 And that, again, I think is something which is, or the market, particularly in equities, has taken very positively here. 154 00:13:33.696 --> 00:13:34.377 Thank you all. 155 00:13:34.777 --> 00:13:36.098 A lot of moving parts. 156 00:13:36.138 --> 00:13:40.382 I think we've got a little bit of a clearer picture about what to focus on. 157 00:13:41.022 --> 00:13:44.765 Thanks for joining me and look forward to further updates. 158 00:13:45.286 --> 00:13:46.026 Thanks for having us. 159 00:13:46.147 --> 00:13:46.547 Thanks, Aline. 160 00:13:52.683 --> 00:14:00.385 So that was Ryan Wang, Deeraj Narula and Alistair Pinder on the implications of the Democrats' sweep of Congress. 161 00:14:01.005 --> 00:14:08.706 Clients can find our full coverage of the U.S. midterm elections on our website at research.hsbc.com. 162 00:14:09.546 --> 00:14:16.068 If you've enjoyed today's episode, remember to like and subscribe The Macro Brief wherever you listen to podcasts. 163 00:14:16.908 --> 00:14:23.594 You'll also be able to find our Asia-focused sister podcast under the Banyan tree in the same place. 164 00:14:24.615 --> 00:14:25.776 That's all from us today. 165 00:14:26.056 --> 00:14:32.422 This episode was hosted by me, Aline Van Dyne in New York and produced by Tom Barton in London. 166 00:14:32.982 --> 00:14:34.444 We'll be back again next week. 167 00:14:34.724 --> 00:14:37.987 So until then, thanks very much for joining us.