Markets Price in Tech Spending and Midterm Elections

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Patiently here on Fixed Income on AI Ballet.

K.A.

With us, Fixed Income at Goldman Sachs. Amanda Lydon just crushed me yesterday.

She's the boss.

We're going to talk about her Halloween. She gave me my Halloween costume. I'm not going to announce it right now. It's too emotional. Alexis wants me to announce it later. Amanda Lynham is all over the zeitgeist right now in your world of fixed income and AI synthesized with all your expertise, what Goldman Sachs is talking about with on-balance sheet and off-balance sheet debt. Well, good morning.

Look, we.

It's probably worth just kind of separating what's happening in the equity markets over the last kind of 48 hours or so and what's been happening in the fixed income markets for the last two or three months.

Because the move.

Started in the fixed income markets and the move was driven by the sheer amount of issuance that was coming to the market. So initially, beginning of the year, Investors were very keen to get in on some of this AI debt, hyperscalers, some of these kind of chip deals. So investors picked them up, but they kept coming. And at some point, I think investors figured out pretty quickly that, you know, it wasn't just a question of kind of pricing the underlying risk, but it was much more the question of pricing capacity and balance sheet as to how much of this risk could really be digested in a short period in the market. And the result of that was spread widening. To the off-balance sheet point, look, that's

what we follow very, very closely. You've got the deals. You've got the deals that are on balance sheet. But the interesting part, actually, is a lot of these residual guarantees are kind of contingent liabilities. And tracking these to understand actually what the buildup is of this kind of concentration risk in the system is a very important point.

Are you concerned about some of these off-balance sheet financing structures, which presumably we're going to see more of going forward? Because the CapEx numbers I see for a lot of these companies suggest more debt issuance.

Yeah.

So the CapEx numbers are remarkable.

I mean, we think you're probably going to end up north of a trillion over the next kind of two years in the IG space alone.

Wow.

You know, some of these kind of deals with the contingent liabilities are interesting because they're actually shorter duration type of deals. They've got residual guarantee backing. There's some leases involved. And they're actually quite interesting from a structure point of view.

They get rated.

And, you know, is there a concern about those deals?

Not necessarily.

There's maybe more of a concern to think about what the right price level is or spread level is for these deals. But over time, it's important to track what's building up and where is it building up? Because, of course, we're talking about one sector, one factor, which is the AI CapEx boom. And really understanding how it kind of like works its way through the capital markets is crucially important.

Can you explain to our listeners and viewers the bond market in France? What's going on there? Because that was in the news and. You're based in London. You got to think about that. That's part of your job.

What's going on?

So, yes, like when I'm in Europe, France comes up all the time. So, look, I think it's fairly, like, at a certain level, it's really kind of straightforward. Like, France is about 120% debt to GDP. That's a large number.

It doesn't sound good.

What is even worse a little bit is the fact that You know, they're running a five to six percent deficit and they've got three percent nominal growth. So that number goes up by three points every year. And the market needs to fund it. And we know that that journey can't continue indefinitely. There's a debt loading that France will be able to carry because there's a limited amount of investors that will buy it. Now, spreads are widening.

I think 10-year spreads are now 147 basis points over bunds. So those are the German government bonds, which people consider the risk-free rate in Europe. They can widen potentially a little bit further. Now, overlay this with the fact that there's going to be a presidential election. that presidential election is actually going to be quite interesting because there is the possibility that far-right candidate Le Pen could win that presidential election. And then it becomes a question of what happens to fiscal policy post-election. So this side of the election, we would expect way more volatility and no change.

Right.

I have to ask this just because of the time here. I think, hey, it's so important. We witness a new chairman of the Federal Reserve System.

How does.

The tension and dialogue of Chairman Warsh changed the job for the governor of the Bank of England. I mean, I think very little has been said about the knock-on effects of an early Warsh tenure on the other banks. What do you see? I mean, if I asked this of Jan Hatzias, he'd walk out of the room. I can ask you. You know, it's safer. But what do you think?

I think it's a really interesting question. As you know and you're aware, and that's why you asked the question, all of these kind of developed market central banks and some of the bigger EM central banks all talk to each other and they're coordinated and they learn from each other and they compare notes. You know, the Bank of England obviously has its own kind of style, so does the ECB, so has the Bank of Japan. They all have their own kind of political pressures. Those might be quite different to what you're seeing in the US. I would argue that, you know, although there's a degree of personal style that matters, these institutions are kind of very strong institutions, ECB, Bank of England, and I don't think

that a singular change And a new chairmanship, given that it's a very recent change in chairmanship, is necessarily going to drive tremendous change across central banking at this point in time. But let's see how it works out. Let's see how less forward guidance matters.

Let's see.

What these kind of special groups come up with. And then let's see whether that has an impact on central banking, which evolves all the time.

Very good. Thank you so much. Stay with us. More from Bloomberg Surveillance coming up after this.

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I want to do this now. I've got Darius Dale in the studio here, founder, CEO, Macro Research, 42 Macro. Paul's going to go see Cornell Princeton this week. We thank you so much, Harvard, for the coverage that we have on Bloomberg 92.9 FM in Boston, a first-place Harvard football here at Yale. And I can make jokes about Yale in last place, but it's not the time. So it's a kid in Oxford, Massachusetts, who starts out at the absolute bottom. I mean, the bottom of coaching in NCAA football. Tony Reno went on to do this, this.

I think he had, what, 14 jobs before he got to head coach at Yale. Here's a single sentence. The team won five Ivy League championships together. 17, 19, 22, 23, 25. And we've lost Tony Reno. What did he mean for your program?

I'll tell you what he meant for me. We served him pork and beans and hot dogs when he came to my home or in the High Point housing projects when he came to recruit me to Yale. And, you know, it's a tragic loss for our program. He's the best leader that I've ever been around. He's the best leader that many people have ever been around, and he's in a better place now.

What did your parents think when he walked in the door? Oh, is the white guy here?

At nighttime?

Lock your door.

All right, Darius, what are we doing here.

With this market?

We've got a huge week of earnings. We heard from the Federal Reserve. The market's at or near all-time highs within 2% or 3%. It feels like there's some angst out there, particularly as it relates to the AI story. What are the conversations you're having with your clients these days?

Thank you for that pivot. We've been having a conversation with our clients for the last month or so. Our quant systems pivot us to a risk-off-market regime, which is a signal to our clients across the global buy side to take down their gross and tighten their net exposure. go up in quality, up in size, lower in beta.

And that's what they've been doing for the last month. And we're starting to see this kind of cascading sequence of one pod takes it down, the other pod takes it down. And so we're really concerned about that spiraling out of control with such a salient catalyst as next week. We don't have any ability to predict what's going to happen in the elections. All we can do is read and react to our signals. And Our signals are suggesting that the risk of a blue wave triggering a response in the Republican Party to get on board with anti-AI is actually rising.

I look at this, and this morning I'm looking at Amazon tanking. Two days in a row, folks, NASDAQ futures now down a whopping 2.5%. NASDAQ on futures down 8% plus over the last number of days. Joe Feldman over at Telsey says Amazon is a robust, solid, strong future. How do you as an investment guy get beyond the panic to some sell side report that says climb on board now? How do you do that exercise?

Well, as a business owner, we obviously forecast our revenue, cash flows, et cetera. And I have no ability to forecast my cash flows in 2029. So when I see reports like Oracle saying they're going to be free cash flow positive in 2029, not understanding the amount of demand for compute that we're going to have in the economy from companies like mine that need to purchase it, to me, it raises an eyebrow. One thing that also raises an eyebrow as it relates to this broader AI thing in the political cycle is next week, we have not just the actual midterm elections in the 36th gubernatorial elections, which could be a really negative catalyst in terms of slowing growth rate of all the AI CapEx. There's another catalyst

that I don't think enough people are talking about, but hopefully they will start to talk about, is there are three wealth taxes on the ballot, California, Colorado, Washington.

If those wealth tax.

Votes go in a way that's obviously not favorable for Wall Street, you're going to have two catalysts that are negative. One catalyst is you're going to force billionaires to actually, you know, sell assets and raise cash that's negative for the But from a longer-term basis, in our opinion, we think that will be a signal for 2028. And you're going to get a signal that candidates will start to campaign on significant redistributive policies, which will challenge the free cash flow assumptions that hockey staked back to positive in 2028, 2029, and 2030.

What did you make of our Federal Reserve yesterday, Tom? It was all over it with his Fed watch on the Fed day.

I was medicated. Yes, exactly.

You were being kind.

What did you take away from that?

So let's set the chairs condescending delivery aside because I think we're all getting tired of it.

The Federal Reserve. So said the gentleman. There was some massive shaking. Good morning, Robert Schiller.

So setting that aside, the Fed has an impossible dilemma right now because two percent inflation is not compatible with winning the race. if in fact the administration is being honest with us, that this is truly a national security imperative and not just a race to more corporate profits.

That's the single smartest thing I've heard on this conundrum, Paul, in months and months. There's a bigger picture here than Fed parlor game, if you will.

And this is why we think, you know, we do believe this market regime gets worse. And so ultimately you're going to see more credit spread. You're going to see multiples come down, but you have to buy this dip because we ultimately believe that Fed Treasury Scott Besant, Fed Chair Kevin Worshen, David Zervers from Jeffries, Spooze and Chartreuse.

They're down there working on something. And in our opinion, we think it'll be a liquidity backstop next year.

Let's go back to the heritage of Yale economics here. I think of Edward Yardeni, the Cowles Commission, the giant James Tobin and all.

Of course.

Yale 101 is you inflate your way out of a debt crisis. You inflate your way out of an industrial.

Policy, which is AI. Exactly.

That's the only solution, right? 100%.

And so that, in our opinion, that's where we're headed. We think the markets aren't ready to price that risk in. We think the next trade, the current trade, is downshifting the growth expectations. We're at cycle highs for 2027 revenue and earnings growth. Right now, cycle highs heading into one of the most salient negative catalysts any of us has seen in our careers.

Our macro weather model currently views the positioning cycle as a meaningful headwind for asset markets. Am I selling here? What am I doing here?

Well, respectfully, we would have said to sell in September when our system's triggered risk off. But in our opinion, if you're fully invested here, you need to, at the bare minimum, downshift your beta, rotate into things that are less high beta, less cyclical, up in quality. In our opinion, we think there's going to be more spread, widening, more multiple compression before we get to a happy place.

How does.

Anybody hedge AI, do you think, these days? Because it just feels like it's everywhere. I can't buy a utility stock for the safe dividend because they've run up on the AI trade here.

What do I do? My clients are going to kill me for saying this, but the long end of the treasury curve. You're talking about a risk-off deflation market regime, a Q4 2018-style scenario where the market, where the street goes, buy that. In our opinion, we think that risk is severely underpriced right now.

Does the 60-40 model work here? Based on the conversations we have in the studio, I'm not so sure it does because I don't hear a lot of people, Paul, saying price up, yield down on bonds.

I don't know.

I can get a 5% coupon on a 10-year. I'm sleeping soundly over that.

In our opinion, the 60-40 model does not work unless you get a risk-off. You need to have a risk-off sentiment in financial markets. You need to go into a deflation market regime. And right now we're in an inflation market regime. The only thing that'll get us into a deflation market regime is a slowdown in data center.

Get halfway there. If we have a disinflationary vector of some form.

We don't.

Some people, some people are predicting we will. That's a seismic shift if we get it right.

It's pretty good forecasting. We don't see any disinflation in the system right now. I heard a guest say we're going back to two percent inflation next year in Q2 because of the comps. But in order to get 2% inflation, you need to at least see some 2% prints on a three-month annualized, six-month annualized before you get there on a year-over-year basis. And we're still not seeing that when you look at CPI or PCE.

Derek Still, thank you so much. Particularly, thank you there. Stay with us. More from Bloomberg Surveillance coming up after this.

You're listening to the Bloomberg Surveillance Podcast. Catch us live weekday afternoons from 7 to 10 a.m. Eastern. Listen on Apple CarPlay and Android Auto with the Bloomberg Business app or watch us live on YouTube.

We're going to do a hard shift here. Professor Portis in London was listening to our discussion going, oh, those crazy Americans. But we're now going to speak to the esteemed Rhodes Scholar of another time and place, always at the London Business School. Richard Portis, thank you so much for joining us. What does it mean to replace Lagarde?

Replacing Draghi at the ECB was an exceptionally large task. How large a task is it to replace Lagarde at the ECB?

First, thank you for having me. But second, it is a big task. She has done extremely well. She had one misstep very early in her tenure when she talked about my job is not keeping spreads low. But beyond that, she has been a safe, sure, forward-looking steward of the ECB and has commanded a very consensual council of the ECB.

You don't hear any leaks coming out, as you do sometimes from the Fed, of dissent within the ranks on monetary policy.

How has Chairman Warsh changed the dialogue of central banking?

It's hard for me to say from the outside.

You know, those central bankers meet every two months in Basel and on other occasions, of course. And I think there's doubtless a pretty good rapport between Warsh and Lagarde. I've seen them together on a couple of occasions and in meetings. And they certainly get on perfectly well. And I think as far as monetary policy is concerned, obviously, the ECB takes into account what the Fed's likely to do and the Fed takes into account what the ECB is likely to do. And they both sort of look at the Bank of Japan. But otherwise, there is some degree of tacit coordination there.

Professor, for our listeners, for our viewers, can you give us kind of your overview of just where the European economy is today? What are some of the challenges here that the EU is dealing with at the moment?

Well, there is the productivity issue. It's a longstanding issue. And productivity growth in the European Union is not as high as it has been in the United States. And that requires measures that central bank has no role in. Otherwise, Europe is hit much harder than the United States by the price of oil we import here. And I'm talking about the UK as well as the European Union.

We import a very substantial amount of our oil.

And that has hit so that there are problems there.

Otherwise, there is the usual stuff, as I say, what's happening to productivity.

And it's not a positive verdict, I'm afraid. And that requires a lot of policy measures that governments have been reluctant to take when it's a matter of governments, and that the European Commission has not been particularly aggressive about. So I think there's, are significant problems here.

Professor, is there any sense, just Across Europe in general, I mean, as we morph into this AI-driven economy and technology becomes more and more a part of daily life, is there a sense within Europe that, boy, we need to improve our productivity to solve some of our challenges here? Because it can't just be the state day in and day out bailing folks out.

No, I don't think there's any expectation that the state will bail everybody out or actually contribute significantly to an acceleration of growth.

What you need is more investment.

And indeed more investment that incorporates AI and is forward looking.

There are some signs, you know, there are some.

Areas in Europe which are where innovation is Innovation proceeds very, very well. You have a number of unicorns in Sweden, for example, and I think as well in Finland, where you have tech-based.

Activities. You have Mistral in France.

But if you look around, there's not enough of that. And that's where the priority should be.

I know we'll speak to you numerous times before this French election, but it's almost parliamentary chaos, frankly, somewhat like what we see in Israel right now. What does the middle look like to Richard Portis, the Macron middle? What does it look like in 2028, 29?

It's very hard to project that far, actually. I'd like to be able to say what it looks like in 2027. The middle is, to some extent in France, has been squeezed out. And the question is whether Glucksmann and others, I'm talking about the moderate left leader, whether.

They can muster enough support. But meanwhile, you have very negative forces on both the right, Le Pen, and on the left, Mélenchon.

And they have to be the center has to put itself forward.

And so far, it hasn't done a very good job of that.

What I'm doing, Paul, is I'm setting up Professor Portis here for the money question. Professor, I've got to make some news this morning. Would you suggest that Christine Lagarde could enter French politics with Edouard Philippe and somehow aid a rebuilding of the center tendency?

I don't think Christine Lagarde is.

leaving early because she wants to get directly into French politics. I think she wants to be free to comment on, to be in the public sphere in French politics. But I don't think she has any ambition or likelihood of becoming a figure in the political scene.

We have to leave it there. Richard Portis, thank you. Thank you so much for the London Business School. can't say enough about his transatlantic vision. Stay with us. More from Bloomberg Surveillance coming up after this.

You're listening to the Bloomberg Surveillance Podcast. Catch us live weekday afternoons from 7 to 10 a.m.

Eastern.

Listen on Apple CarPlay and Android Auto with the Bloomberg Business app or watch us live on YouTube.

Good morning, everyone. Thrilled that you're with us. Thrilled that Natasha Saron is with us. Co-founder of the Yale Budget Lab. These people are eclectic. They came to my attention as my, you know, thought leader. I hate the phrase thought leaders, but I'm going to use it here.

Tariffs.

They killed tariffs.

I know.

They come out with a ton of good data and analysis.

You know, and they got a little political tinge, but basically they're trying not to be too nuts on the politics. Natasha Saron driving this forward, and she's got out today the headline that is the quiet undercurrent of this election. Tax the rich, question mark. Easier said than done. Natasha, what have you learned at the Yale Budget Lab about the California proposition or the other propositions to come in 49 other states?

Well, thank you so much for your kind words about our work at Budget Lab. I am lucky to work with some really remarkable people. Yeah, spend time day in and day out trying to like build the analytical infrastructure to be able to analyze some of these proposals. And we've been doing a lot of work on taxing the top and really like how much income there is potentially, to tax and what are the right types of tax instruments that might let you get that income in a meaningful way. And the point of my piece this morning was that California is debating this wealth tax measure on its about 250 billionaires. I speculate that while I'm like incredibly sympathetic with the aim and like billionaires absolutely should

pay much more in taxes. This particular ballot measure has some problems that you're already seeing play out in practice. I mean, you're watching billionaires like Sergey Brin and Larry Page vote. like up and leave the state, that is going to cost money not just from the wealth tax coffers, but also from the fact that they're no longer going to be paying California income taxes. And so there's some estimates out there from Josh Rao at Stanford and his co-authors that suggest that as a result of that, this tax is actually going to be a net negative for the state.

It kind of goes to the issue, Natasha, as we get ready for midterm elections next week, that once again, it's probably it's the economy, stupid. And I guess this year's format of that or a version of that is just affordability and inflation and all that kind of stuff. How do you think about that for the average household out there?

Yeah, it's so important because if you ask people about how they are thinking about approaching their vote in the election next week, cost of living issues are like so front of mind for every person, essentially, no matter what their political affiliation is. And by the way, 2024 was a cost of living election, which Donald Trump won in large part because people were frustrated by inflation. And he said, I'm going to lower prices on day one. We have another one in these midterms and I speculate we're going to have another one in 2028. I have a piece actually that I wrote for The Times last week where I argued that I'm a little nervous about the idea that you have politicians who are trying to come up

with like quick fixes and to affordability, things like cut prices on day one or rent freezes, when the reality is that things like housing, child care, the cost of elder care in this country, all of these are structural issues that are going to require really thoughtful long-term policy solutions to.

Try to address.

And so I think we need to think seriously about dealing with this issue of economic precarity, the feeling that You know, I feel like one potential crisis away from being off the brink.

Natasha Saron, as we look at the fancy people, what they're paying in tax, I would say what's less spoken of because it's not so visceral with our audience, Natasha, is corporate income tax in the 1960s, 4% of GDP tax. craters with Reagan down to 1.5% of GDP. And even today, well under 2% of GDP. Is that a solvable fix?

I mean, Exxon today, what? More money than God, $ 20 billion share buyback. Solvable.

This is so solvable and so important. And by the way, if you want to tax the rich, a really good way to do that is by doing a better job of taxing.

The companies that they own.

And I have this view that essentially you're absolutely right on what's happened to the corporate tax over the course of the last few decades. And even just in the last decade, you saw the corporate tax rate in this country go down from 35 to 21 percent, even though corporations, they were actually asking for 25. So they got more than they had even aspired for as a result of legislation passed in the first Trump administration.

Right.

I think there's so much revenue there because these are massive, hugely profitable companies. And by the way, we can leave the rate in place for 98% of companies.

Okay, but I got to get this in before the market opening. Can I ask an Ernie Tedeschi question? Like a nerd question. Can we garner more corporate tax efficiently and fair without messing with a lot of people?

We definitely a thousand percent can. And it's just about the top two percent of the most profitable largest multinationals you can raise on the order of hundreds of billions of dollars over the course of the next decade.

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Markets Price in Tech Spending and Midterm Elections

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