Investors’ Outlook: A shorter leash

A shorter leash

The global economy is still moving along, although the ride appears to be getting a bit bumpier. Oil prices have thrown a wrench in the works. The war with Iran temporarily pushed them back above USD 100 per barrel, feeding into inflation and contributing to upward pressure on bond yields. Oil prices have retreated from those highs, but the recent period of elevated prices has left inflation concerns sitting on central banks' desks. 

Several have raised rates this year, quite the U-turn from 2025, when rate cuts were the order of the day outside Japan. The Fed joined them in September, unanimously raising rates by 25 basis points (bps). A quarter percentage point is almost neither here nor there. Monetary policy can’t bring down oil prices, but a 25bps hike also doesn’t really restrict money in such a way that it would slam the brakes on an economy that’s still growing. However, the mood music at the Fed suggests that it wasn’t one and done, with at least another hike signaled before year-end. Markets have made a big leap, going from expecting three rate cuts through next summer to pricing in almost four hikes by July, though that looks rather aggressive to us.

Another number has been hanging over markets. The 10-year US Treasury yield crossed 5 percent last month, its highest level since 2007. If history is any guide, a first hike alone hasn’t been a cue to head for the exits in equities, but yields climbing without stronger growth to show for would be a bigger concern.

And at this point, a bubble in capital expenditure (capex) in the artificial intelligence (AI) space is also worth a few words. Things can move fast, and that’s one way we could move down this late-cycle path. Markets have become more nervous that everything hinges on the US consumer and AI capex. If there are any wobbles in potential AI spending, we believe the risk of a bubble would become palpable. The market has been vigilant so far, not overdoing it with valuations, and investors have been taking it quarter by quarter. Companies like Nvidia still beat expectations, and hyperscalers have been able to show that cloud demand can go higher. But if those capex plans are suddenly revised down, that could trigger a selloff in equities, especially considering how much money investors have already made from the AI theme. For now, we see no signs of such a pullback, so we remain positive on the outlook for equities, though it’s something we’re keeping an eye on.

In this Investors’ Outlook, we consider what the upcoming US midterm elections could mean for markets, explain yields’ interplay with equities, and take a closer look at the US dollar and other major currencies.

Markets may have a little less room to run, but we still see plenty of opportunities to make capital earn its keep.