The European Central Bank (ECB) seems to have reached the end of its interest rate-cutting cycle with a deposit rate of 2%. But the Bank of England is stuck at 4%, thanks to sticky inflation (especially wages in the service sector, partly a result of government policy). Investors are now looking forward to the US Federal Reserve resuming its rate-cutting cycle, which has been on hold for a year.
Trouble at Fed
It’s been all-go at the Fed over the summer.
One governor, Adriana Kugler, resigned. This allowed Trump to propose the Chair of his Council of Economic Advisors, Stephen Miran, as her temporary replacement. Last year Miran co-wrote a report on reshaping global trade; his recommendations on tariffs informed the President’s policies, including Liberation Day. It’s fairly clear who’ll be pulling his strings.
Fellow governor Lisa Cook is fighting to retain her post against charges of making a fraudulent mortgage application. Whatever the truth of the allegations, they’ve been politicised to the extreme. Trump is using them as a lever to force her departure, replacing her with someone more likely to do his bidding. The President continues to argue that interest rates are too high. But then, as a property developer, he probably regards anything above zero as too high.
We should be careful what we wish for. If interest rates are lowered for ideological rather than economic reasons, investors could react badly. If the independence of the Fed is compromised and power over monetary policy is seen as in the President’s hands, then fears about higher inflation could dominate the narrative, raising Trump’s borrowing costs. Bond investors have already sent a few warning shots to governments this year about the risks of fiscal profligacy, with the US, the UK and France at the sharp end of a scolding.
Investor worries are also evident in the inexorable increase in the price of gold, another asset hitting new all-time highs. For now, most investors are treating the prospect of a supine Fed setting rates that are too low as a tail risk to be hedged rather than something that should shape core portfolios. But gold’s message cannot be ignored.
UK Budget countdown
The date of the UK Budget has been fixed for 26 November. Labour is under intense pressure. Losing one cabinet member (Angela Rayner) because of ill-advised personal financial decisions was, perhaps, a misfortune. Having to sack the UK’s ambassador to the US because of undisclosed letters of support to a convicted sex offender begins to look like carelessness. This Budget is being set up as something of a last chance for Chancellor Rachel Reeves to right the ship. We’re set for another long period of policy kite-flying and speculation. This will be unsettling, as it was in the runup to last year’s event. We’ll get into the nitty-gritty details of potential spending cuts and (more worryingly) tax increases in the weeks to come, but this has all the makings of a red-letter diary date.
The AI train rolls on
Perhaps the biggest question for investors is whether shares of companies investing in or benefitting from the AI boom will continue to prosper. Recent research from Société Générale, the French bank, tracked the performance of various thematic baskets this year. The outright winner was Global Nuclear. Demand for nuclear energy is rising strongly. It’s clean and consistent, even if expensive to install, and sits well with the enormous potential demand from data centres.
And, indeed, Global Data Centres was the second-best performing theme, despite a few blips. First came January’s scare caused by the DeepSeek generative AI model. The Chinese company claims the model uses a lot less processing power than US rivals, which suggests less demand for data centres. In April saw the Liberation Day tariffs, which threatened to push up the cost of the hardware and construction materials needed by data centres. Finally, August brought a well-publicised paper from MIT Nanda, an academic initiative linked to the Massachusetts Institute of Technology. It suggested genuinely successful adoption of AI was currently low – raising fears about returns on all the investment. The Economist magazine raised similar concerns in last week’s edition with the leader headline: “What if the $3 trillion AI investment boom goes wrong?”
It looks as though investors are more than willing to give companies the benefit of the doubt for now. The latest sign came with the publication of third-quarter results from US software company Oracle, which gained 25% last week. It briefly threatened to join the exclusive $1trn market capitalisation club when it was up 40% at its highest point – making company founder Larry Ellison the world’s richest man for a few hours. The news of a tripling of its committed forward revenue since the last quarterly update, to $455bn (much of it tied to data centre development), was undoubtedly impressive. But analysts think $100bn of that is from ChatGPT owner OpenAI, which currently only generates $13bn of revenue a year. This highlights the fever-pitch level of expectation.
For anyone worried about another tech bubble, more soothing analysis comes from US bank Goldman Sachs. It calculates that since the start of 2009 (in other words, in the period since the Global Financial Crisis), the tech-laden Nasdaq index is up more than 20 times. The breakdown of those returns is encouraging: 74% is thanks to earnings growth; 16% is from dividends; just 10% is attributable to valuation expansion. As long as earnings are expected to rise, this train can keep rolling. The key risks revolve around the speed of adoption of AI and the ability to start generating revenue from the currently high capital spending. Our analysts are watching both factors like hawks.
But if companies start disappointing, it will probably be near-impossible to predict the exact timing when markets reach a turning point, when optimism fades and profits are banked.
