Top of the Morning: CEO Macro Briefing Book - Election digestion
The desk frames the post-midterm election landscape as a significant moment in U.S. market dynamics, marked by notable volatility and shifts in investor sentiment. Per the full note from UBS, the election results are seen as a clear rebuke of the current administration's priorities, which may facilitate increased market volatility. The implications for market positioning and potential sectors to watch—particularly around financing and AI—suggest a recalibration of strategies for institutional investors. The market response indicates a re-evaluation of risk assets, particularly U.S. equities, amidst these political changes.
What the desk is arguing
The desk posits that the U.S. midterm elections have catalyzed a notable shift in market sentiment, as investors digest the implications of a changing political landscape. Paul Hsiao from UBS asserts that the election results symbolize a generational shift in power, fundamentally rejecting many of the current administration's policies, particularly around technological advancements like AI.
Market response has been swift, with U.S. equities experiencing significant swings—indicatively, large and small caps rebounded strongly post-election. This reaction signals a potential boost in risk appetite as investors reassess their positioning in light of new governance dynamics and market opportunities.
Where it sits in our coverage
Our current consensus target for the FX market sits at 1.075, with a range between 1.04 and 1.12. Notable targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This view leans toward the upper bound of the anticipated range, suggesting a bullish sentiment following the election outcomes that contrasts with the more cautious stance observed by bofa.
How other firms see it
Markets are generally aligned with the bullish sentiment observed in this commentary, particularly among firms like jpmorgan and citi, which reflect optimism regarding fiscal dynamics in the wake of the elections. Conversely, bofa remains skeptical, indicating a more conservative approach due to potential economic headwinds.
To contextualize this scenario, the fluctuations in U.S. equities could directly influence USD dynamics, particularly in pairs like USD/JPY which may be sensitive to shifts in market risk appetite.
What the calendar says
With no high-impact events on the calendar in the coming weeks, traders should remain vigilant to any unexpected political developments or economic data that might influence market sentiment as the effects of the midterm elections continue to play out.
02Shift in investor sentiment towards risk assets, particularly equities.
03Potential recalibration needed for portfolios focusing on financing and AI sectors.
04Political developments could lead to further market shifts.
Market implications
Traders should watch for further volatility in U.S. equities as the implications of the midterm elections unfold. Key levels to monitor include the 1.075 consensus target, with a close eye on risk signals emanating from shifts in political dynamics.
Risks to this view
The primary risk that could invalidate this bullish call is a sudden pivot in economic data or macroeconomic indicators that suggest a weakening recovery, potentially forcing a reevaluation of market positions and leading to a downturn in risk appetite.
ubs
Hi, everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. For today, we do have a special election digestion edition of the CEO Macro Briefing Book series from the UBS Chief Investment Office, as we will spend some time assessing the market response in recent days.
We'll cover the implications of the election outcome to financing, dealmaking and the progression of AI buildout. Joining me for the conversation, glad to welcome back from the UBS Chief Investment Office within UBS FSI, a Senior Asset Allocation Strategist for the Americas, Paul Hsiao. Paul is also a co-author of the recurring CEO Macro Briefing Book series, which we often cover here on Top of the Morning.
So with that, Paul, good morning to you and thank you for dropping by on this Thursday morning. Thanks for having me, Dan. So, Paul, a lot to assess in the days following the U.S. midterm elections, which just took place on Tuesday.
Let's start with the market response. We have seen some notable market swings, in particular within U.S. equities over the past 48 hours. What's your overall assessment, Paul, of how markets are responding to the election outcome?
Thanks, Dan. I think it's worth putting this market response in a broader context. What happened in the midterms was just not your garden variety flavor of the party switching during the midterms, but it seemed a lot more like a generational change of power when it came to many parts of this country.
I think it's impossible to view the election outcome as anything but a rejection of a lot of the White House's priorities. But interestingly enough, the issue of AI came up in a lot of ballots, I think. Data centers came on the ballot at least 10 times, or at least across 10 jurisdictions in the U.S., and they were summarily rejected 10 times by the voters.
So, that's something to keep in mind when you go over the market reaction. So, we did have large caps and small caps rally after the election. I think that's largely based on markets viewing the election in general as a risk-clearing event, and it really follows in history where you have flat performance in the S&P 500 leading up to a midterm, but once you have the clearing of the midterm cycle, then you have equities starting to take off.
But I think the notable thing is not only did large caps take off, but so did small caps. So, the rally was actually quite strong. Where the rally wasn't as strong is, I think, largely based on the issues that I talked about.
So, the Iran war, I think, was a popular topic on the ballot yesterday, or at least in spirit. And the idea is that with more democratic oversight in the House and Senate, there might be a reduction in geopolitical tension. So, that means lower oil prices, and we saw oil prices drop more than 8% in one day.
And that's also followed by a sell-off in S&P 500 energy as oil price drop hits producers as Democrats presumably scrutinize the Iran conflict. So, I think that's one sort of market nuance to watch out for. The other one to watch out for is that data center AI-related trade.
I think SMEs have come under pressure over the last couple of weeks with higher rates and then more scrutiny over how sustainable the CAPEX cycle can have. And with data centers being rejected at the ballot, and the idea is that with House Democrats and Senate Democrats, there might be more scrutiny on AI-related developments. So, that led to SMEs selling off, I think, pretty significantly.
Since data center limits actually threatens chip demand. When it comes to rates, I think it was much less dramatic than what we saw in the equity markets. We had the shorter end yield decline by about five basis points, and I think that's related to lower oil prices reduces the pressure on the Fed to imminently hike, although markets are still pricing in a hike in December.
Interestingly enough, we had the longer end also fall. And I think part of that is due to lower rate high expectations, but midterms also, especially with a divided government and gridlock, it also serves as a check to the executive. So, it's a reinforcement of institutional credibility, which tends to reduce long-term bond yields, but also puts a check on any further White House spending plans, which have been passed over the last couple of years.
So, I think a lot of different market dynamics going on underneath the headlines as a result of this election. Now, oftentimes, Paul, on the podcast, we do spend some time talking about the landscape for financing and dealmaking. Given the outcome of Tuesday's midterm elections, any notable implications to speak of to both financing and dealmaking as we look ahead?
Right. Maybe I'll talk about the financing before I talk about the dealmaking part of it. But the idea is that will gridlock lead to lower yields?
And we've talked about on the margins, yes, but I think fiscal concerns matter more. So, deficits are still quite wide, and I think going into 2028, dealing with the historically wide debt levels is something that Congress, as well as the executives, will have to deal with. Whether that is cutting back on government spending, that's obviously quite difficult, given a large part of government spending is Social Security and Medicare, which are political guardrails.
But also, will they actually start to raise revenues, which, all things being, will tend to be growth-restrictive and not a popular policy for any party to enact. So, that's something that I think future lawmakers will have to contend with. But right now, debt levels are still quite high.
The deficit is historically wide, given the low levels of unemployment. So, gridlock is seen as quite stable, so that puts less pressure on yields to go higher. But 10-year yields and 30-year yields are close to the highest points that they've been in, in at least recent memory.
So, unless the fiscal situation gets materially better, it's hard to see longer end rates keep going materially lower, especially if the Fed is going to hike at least two more times through the first half of 2027. So, financing costs, we think, will remain elevated, and we think that business owners should lock in fixed rates when you can, and don't wait too much longer for lower rates. When it comes on the deal-making side, I don't think that M&A conditions will materially change, since Democrats have limited control on antitrust reinforcement.
But there might be more efforts to slow deal-making activity. We can expect House Democrats, or even Senate Democrats, to hold hearings on monopoly efforts when it comes to big tech or data center build-outs, which provide some headline risk. So, for sellers, the next 12 to 24 months can offer a stable regulatory environment from a more permissive White House, and might motivate some PE buyers.
And for buyers, expect continued competition, and corporate buyers are still paying a pretty hefty premium compared to their PE counterparts. So, that's something also to keep in mind. Another point of interest being investor concerns over the progression of AI build-out development.
Mindful that Democrats have full control of Congress comes January 2027. How is CIO thinking about this? What are the concerns to speak of?
The U.S. has been a bit slow relative to other major economic counterparts when it comes to AI regulation. We've seen more efforts in places like Europe and China, for example. But broadly speaking, data centers and AI remains unpopular on a bipartisan basis from the public.
So, we do have some Democrats campaigning about limiting AI. The Democratic governors in Texas, Ohio, and Georgia definitely come to mind, Texas especially because it holds 27% of U.S. data center capacity. So, it's definitely worthwhile to see what the new governor may or may not do when it comes to slowing up some of the works.
For us, I think it makes sense for chips to reprice as an already crowded trade. But some of the existing cloud service providers have actually rallied because existing compute power and existing cloud capacity might become more valuable as data centers become slower to come online. So, what this means is that the energy cost related data centers might go down or remain stable, but smaller businesses or business owners may have to think about their AI spend or cloud servicing spend either remaining at elevated levels or going up if demand holds the same and just the amount of cloud services that is provided is going to slow in the coming years thanks to increasing regulation.
Well, Paul, very timely insights. Thank you again for dropping by Top of the Morning on this Thursday for some perspective on the market response. We covered the financing, deal-making landscapes, as well as the progression of AI build-out in the wake of this past Tuesday's midterm elections.
Looking forward to our next conversation. Thank you very much for having me, Dan. Thank you for tuning in.
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