Macroeconomics: The Day Ahead for 14 November

** U.K. – the climb down by PM Starmer and Chancellor Reeves on hiking income taxes is not really news, given that Lucy Powell’s election to deputy leader of the Labour Party reinforced the deep divisions in the party, which render Labour’s parliamentary majority irrelevant. The moment that Powell declare that Labour should stick to its election pledges on taxes, any increase in income taxes was dead in the water. There is obviously a mountain to climb in terms of how the budget can manage to restore some order to the UK’s fiscal position. But bear in mind that since the end of WWII, the default position for every govt had been to slash investment spending above all on infrastructure (one would have to add that this has also been true in many other G7/EU countries), which is why this is such a major challenge in the face of the economic and social transformation being driven by AI and the energy transformation.

** Tech – there have been so many stories that flag up the challenges to the AI bubble euphoria, I have picked out two in the collection below. A cursory look at Mag7 earnings (with the caveat that one does need to a deeper dive to make important differentiations) highlights that ‘hyperscaling’ AI investments means that CapEx at most companies is running at a minimum of 5x revenue growth. Per se the ‘free cashflow’ which has long underpinned their ambitious valuations for ‘big tech’ is being eroded at a very rapid pace (one might well equate this to the rapid cash burn witnessed at many ‘darlings’ of the dotcom bubble). Throw in the likelihood that much of this investment will probably be a case of ‘paying up to look big’ (or ‘Go large or go home’), and will not generate the ROI, the improvements in efficiency, or innovations that will drive future profits, as well as the rapid and eye watering accumulation of debt to finance these projects, and the word ‘caution’ becomes the watchword for the near term. To be sure, and as was the case with the dotcom boom, this will in the long run be a huge positive for the global economy, but it is not going to be a linear progression. It is also worth considering how lessons from Japan’s Zaitech (financial engineering) bubble that ultimately resulted in its lost decade, and also the various episodes of companies investing in each other’s projects (be that property, or the complex cross holdings in Japan and South Korea for example, or the example of Enron) might be applied to this. One should also note that the boom in AI related spending accounts for much of the ‘resilience’ in growth in developed economies, and is masking very adverse trends in other sectors of manufacturing, which high levels of uncertainty (low visibility, elevated interest rates and inflation) and trade tariffs and tensions are exacerbating, in other words creating a lot of unhealthy imbalances, as well as a distorted picture of the global economy (excepting Asia overall, though the picture is unitary).

** China – today’s run of data underlined that whatever benefits there have been from the piecemeal stimulus packages over the past year have run their course (do read the story on ‘phantom loans’). China remains mired in deflation, and it remains to be seen how much the measures to combat ‘involution’ will work, and the need to implement of what was announced for the new 5-year plan quickly and forcefully is more than imperative, it is very urgent. Yes, the sharp 25-27% y/y drop in exports to the US has been balanced by robust increases to Africa (ca. 51% y/y), Asia (ca. 15%) and EU (11%), but the weakness of domestic demand, above all the millstone of the property sector woes, is the most pressing policy issue that the authorities must address.

** Eurozone – the news that the EU and UK are looking to pool access to their large pool of USD holdings (i.e. liquidity) given the ambiguous US policy stance (Fed words have offered comfort on this, but ultimately it is the US Treasury and Congress which will have the last word). Such a measure to poll resources would be a lot more effective if a lot more progress had been made on banking union, to which there remains enormous political resistance, but at least there is an awareness that there are tools at Europe’s disposal to at least partially firewall itself from US policymaking. By contrast the latest moves by the German govt to support the airline industry, and other measures to prop up its ailing economy, should be a warning that some of the EUR 170 Bln earmarked for infrastructure and defence/security investment, may end up being diverted to fill holes in current (i.e. day to day) spending.

** U.S.A. – As much as the stop gap spending bill to end the government shutdown has generated a positive response from markets, it merely defers another day of reckoning on the federal budget until the end of January. It is also true that US election years have acted as a deterrent for shutdowns, per se implying that a further shutdown is unlikely ahead of next November’s ‘mid-terms’. Perhaps more notable are the stories that the administration has indeed chastened by the results from Election Tuesday, and is looking to implement a further round of tariff exemptions, above all on food items, as well as complete other trade deals (though these may again be ‘frameworks’ for further negotiations) to try and persuade voters that they are trying to dampen inflation pressures on household spending. This along with the household tax rebates that will accrue in H1 2026 from the ‘Big Beautiful Bill’ implies a boost to H1 2026 Private Consumption, but also imparts some upside risks to inflation that should not be ignored.