Macro moments weekly: A lack of crowd control

Key takeaways

• Earnings beats may not be enough. As ASML and LVMH demonstrate, market reactions can depend as much on expectations and previous share-price performance as on corporate results.
• Rising borrowing costs threaten AI investment. Widening credit spreads and higher sovereign bond yields could force companies to scale back or abandon planned projects.
• Government borrowing risks crowding out private investment. Fiscal restraint could help lower borrowing costs and support economic growth, potentially proving as effective as further interest rate cuts.

A Lack of Crowd Control

Earnings season is upon us. While it may not be a make-or-break moment for most investors, the sharp rise in inflation and bond yields in recent months could mean a very different market reaction to corporate earnings this time around.

How much of a beat is needed to get a positive reaction? Well, in the case of ASML, was the reaction one of boredom to a solid, yet predictable set of numbers? Or was it one of being caught in this week’s wave of artificial intelligence (AI) profit-taking? Then again, what about LVMH, which missed numbers, downgraded expectations and yet has seen its shares rise? Then again, ASML is up 61% this year and LVMH is down 38%. Reversals may seem perverse but are quite normal during the third-quarter earnings season—it’s the market just saying: ‘We know that’.

What is not so normal is the sharp widening of bond and credit default swap spreads for several AI companies. We know that the level of long-term debt they have issued is large, dominating issuance in the 10-to-30-year and 30+ year maturity bands. We know this has been a heavy year for corporate debt issuance—approaching the record set in 2021. We know that credit spreads on AI-related corporate bonds have widened, in some cases very sharply. CoreWeave offers one of the more striking examples, with its unsecured bonds trading below 80 cents on the dollar.

As corporate credit spreads have widened, yields on benchmark sovereign bonds have also risen. Together, these developments are pushing borrowing costs significantly higher than they otherwise might have been. There may be concerns, but the primary cause unsettling investors is, of course, sovereign debt.

Last week I wrote about the message being sent by the bond markets: ‘No More’. Now we can see the real impact of excessive sovereign borrowing. The transmission of higher rates to the private sector in the AI space will likely lead to some investments being pulled, projects being lost, capacity planned and never built. As governments have no choice but to return for more and more money from investors, rates could rise again, no matter what happens to growth or inflation.

Simply put, we are seeing the first signs of ‘crowding out’ of the private sector. Worse still, this crowding out is hitting the very sector that could be vital in re-igniting growth. Such growth is vital for increasing tax revenues and reducing deficits. We have not seen such an obvious crowding out since the 1970s.

The remedy is simple—a programme of fiscal discipline from governments—which could have a disproportionately large impact on lowering market interest rates. The IMF said as much this week. Fiscal restraint could reduce crowding out and help reignite growth, perhaps as much as or even more than future interest rate cuts.

Parting Shot

The price of fishmeal has soared. Lower fishing catches, due to overfishing, have led to less waste product alongside the sharp rise in Chinese demand for fresh fish. The replacement protein? Chicken. More precisely, the bits left after it has been prepared for the supermarket. It’s cheap and easily available. But has anyone asked consumers whether they’ll accept chicken-fish?