Top of the Morning: CEO Macro Briefing Book Q4 update
The FX desk views the current macroeconomic landscape as indicative of potential late-cycle conditions amid signs of economic resilience. Per the full note from UBS, Paul Hsiao emphasizes that the current economic indicators such as narrow stock market performance, alongside elevated inflation rates, suggest a fragile equilibrium which the Federal Reserve must navigate carefully to avoid recession. The implications of this analysis are profound for FX positioning as traders monitor how these dynamics play out against the backdrop of shifting investor sentiment. Current forecasts predict a consensus USD trading level around 1.075, indicating situational volatility in the upcoming months.
What the desk is arguing
The desk argues that the U.S. economy may be showing late-cycle signs influenced by both inflationary pressures and stock market dynamics. Per the full note from UBS, this late-cycle characterization is crucial as markets await the Fed's next moves in monetary policy. Hsiao draws parallels to 1994, suggesting that the Fed's ability to manage these pressures without triggering a recession is crucial at this juncture.
Supportive of this view, key indicators reveal how consumer spending and labor market conditions have remained surprisingly robust, despite signs of narrowing stock performance. Hsiao's insights imply that the overall market seems to reflect a cautious optimism in the end game of this economic cycle, with a noticeable push from the job numbers and inflation statistics.
The alternative read would suggest an impending recession based on classical metrics; however, current conditions appear more resilient, challenging more bearish sentiments and affirming the potential for sustained economic growth beyond the late-cycle indicators.
Where it sits in our coverage
Consensus from our coverage aligns closely with expectations, with targets around 1.075, framed by the following forecasts: - jpmorgan: 1.10 (Mar 26) - bofa: 1.04 (Mar 26)
The desk's position lies slightly above the midpoint of the consensus range, suggesting a cautiously optimistic stance as the market grapples with the balancing act of inflation management by the Fed. Positioning by bofa highlights skepticism, framing a bearish view aligned with more cautious market sentiment.
How other firms see it
Firms aligned with this optimistic outlook, like jpmorgan, see potential for further USD strength amidst economic resilience, while bofa offers a contrarian perspective, advocating for a more bearish stance based on impending recession fears. This creates a spectrum of views that exemplifies the uncertainty in the current macroeconomic climate.
Key currency pairs and indicators that intersect this thesis include the EUR/USD which may react to similar pressures from the ECB policy decisions, emphasizing the intertwined nature of global monetary strategies in this environment.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01The US economy shows signs of resilience despite late-cycle indicators.
- 02The Fed's management of inflation is crucial to avoid recession.
- 03Market positioning is divided, with bullish and bearish firms presenting contrasting FX strategies.
- 04The current consensus target for USD reflects cautious optimism amidst economic uncertainties.
Market implications
Traders should focus on the 1.075 USD level as a critical point for potential volatility. Monitoring labor reports and inflation data could shift sentiment, particularly if they deviate significantly from current expectations. The Fed's next actions will be crucial for directional moves in the FX landscape.
Risks to this view
A significant downturn in consumer spending or dramatic job losses would invalidate this bullish call, likely provoking a more aggressive Fed response that could lead to a stronger USD backlash. Additionally, any unforeseen geopolitical developments could shift market dynamics abruptly, impacting the current outlook.
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. For today, we will focus on the latest iteration of the ongoing CEO Macro Briefing Book series from the UBS Chief Investment Office.
The update for Q4, joining me for the conversation today from the UBS Chief Investment Office within UBS FSI. Glad to have back on the line today, Paul Hsiao, Senior Asset Allocation Strategist for the Americas. Paul, good morning to you.
Thank you for dropping by. Nice to have you back. Nice to be here, Dan.
Thanks for having me. And Paul, as our listeners know, we've been having these ongoing conversations as it relates to the CEO Macro Briefing Book series, which caters to small business owner clients for the past year. So with that context, and we're recording here today on Tuesday, October 6th.
From your vantage point, Paul, where is the market telling us where we are in the cycle at the moment? Yeah. So if I just take general market indicators, where rates are, where inflation is, how narrow stock market performance has been, these are generally are signs of late cycle conditions right before a recession.
We think that it's more like the 1994 when the Fed was more primed to stymie inflation by raising rates. And Greenspan was able to do that without causing a recession. Hence, I think at that point, he was called the maestro.
So I think the test for Chair Warsh is whether his reading of the economy is really accurate at this point, given how strong some of the jobs numbers have previously been, if you exclude last month's print, elevated inflation, but also narrow stock market leadership. So it's really a test for the Fed right now, but really there's no reason to think that we're necessarily in late cycle. Right now we're about six years from the last recession, and generally cycles have become longer and longer.
I think the last one we had from 2010 all the way to 2019, it was almost a decade. And it was really where policy rates, it was really upended, not by policy rates, but rather by a pandemic. So there's no reason that cycles can die of old age.
We think that, at least the Fed thinks that right now rates are high enough where it can slow the economy by removing accommodation. And that's generally our point of view, that the economy we think will moderately decline going to Q4, but not necessarily slow down where it will cause a recession. And generally that tends to be good for an earnings backdrop.
Interesting. So, Paul, do you think Fed policy is too restrictive from a business perspective? Right.
I think the difference now is twofold. One is that growth is quite strong, and the second is the difference between this cycle and the last cycle, and the one we had right after the financial crisis, is really this seems to be a supply-driven cycle, which tends to make the economy less interest rate sensitive. So on one hand, you have nominal growth rate around 5 to 6%, which is really, really strong.
And I think an underappreciated fact that really since 2020, nominal growth has been up around 56% compared to 2019 numbers. And that's really essentially adding like two UKs since that point. So the economy in the US, which is a nominal term, is actually doing quite well right now.
And what we're trying to do with the rates is figure out what is the appropriate level of rates where you can slow the economy by slowing inflation back to what the Fed considers to be its target of 2% without causing a recession. So clearly over the last couple of years, the economy has been able to take higher rates. That said, with more hawkish expectations priced in during the summer, alongside fiscal concerns, we've had both the short end and long end going higher.
That has led to valuation compression in the S&P 500, and I think for a lot of businesses that essentially has tightened conditions with only one rate hike. So with the weaker jobs numbers that we recently had right now, and I think it gives some space for the Fed to at least pause in October and raise rates one more time in December. And we think that we're more dovish compared to market, and we think that the Fed at that point in December will take an opportunity to have a dovish hike, so make rates pause going into 2027 rather than signal two more hikes, which is what I think the market is expecting.
So policy right now has tightened a bit since the summer, but it doesn't look too overly restrictive from a business perspective. Another topic, Paul, top of mind. We've been talking about this during our quarterly conversations this year, AI adoption.
Over the past few months, Paul, can we get a good glimpse of AI adoption in the macro numbers yet? We're trying to look at it in a couple of ways. The first is survey data from the Census Bureau shows that about a quarter of businesses have adopted AI, and that could go to around 30% by Q1 if current trends hold.
Other private market indices, such as the RAP AI Index, which actually measures the spend that businesses are having on AI models, suggest that number is much higher, around 70%. We think that the number is somewhat in the truth, but the bottom line is more and more businesses are adopting AI in their business practices. And that's really fueling the demand and justifying the CapEx plans for all these hyperscalers.
So CapEx plans, I think, were around $500 billion at the start of the year. That number has gone even higher after the Q2 earnings, when a lot of these hyperscalers are saying that the demand for AI services, AI compute, is just far stronger than what has previously been anticipated. And that justifies accelerating the CapEx spend more than expected in 2026, and we think we'll ramp up to about $1 trillion a year by 2028.
And these are massive numbers, and what these hyperscalers are telling us is that these numbers are justified by stronger-than-expected demand. One more thing. We're not really seeing these yet in the productivity numbers, which I think most economists are watching out for.
But I think one example of how game-changing AI has been from a business perspective is if you look at business applications. That number has surged from the pandemic, when folks were at home, their balance sheets were buffered by some of the stimulus payments during COVID. But really, since the introduction of CheckGPT in 2022, that number has risen to, I think, an all-time high, with many more businesses created than any other point in history.
Many of these entrepreneurs are saying that they're using AI because it eliminates the need to outsource some marketing or have legal advice. It's sort of a one-stop shop, helping a lot of smaller businesses grow, and I think eventually that will lead to productivity gains in the U.S. economy. Turning to the dealmaking space, we've been hearing about delayed IPOs.
Do delayed IPOs show less faith in the market? I mentioned before that higher rates has compressed some valuations. I think for some of the bigger-name IPOs that some of the market was expecting this year, the disconnect between the price that they anticipated to debut and compared to the price they might be, the market seems to be closing in on right now, there might be some differentiation in that.
We did have several high-profile IPOs in the last couple of years, and the performance of them wasn't universally strong. It's more likely been a mixed bag. So I think some of these AI companies that are expected to debut, they're really taking a wait-and-see mode, and I think they might wait until the situation with rates have calmed down a bit, and then I think that might turn with a more dovish Fed going to Q4.
So it's much less not having faith in the market, but still a disconnect between the valuation price that these AI companies think that they might have versus what the market is currently pricing in, and more favorable conditions might happen later in Q4. But so far this year, it's already been a very, very strong IPO year, even with very high rates, which you've historically seen crimp IPO and M&A activity. Like I said, it's much more of a supply-driven market, a less interest-rate-sensitive market.
So even with higher rates, even with the rate hike, we have IPO activity accelerating from last year, and that's already baked in the cake, as well as M&A activity. Finally, Paul, just to touch on the midterm elections about a month away from now, a little less, what are CIOs' expectations and what are the implications of certain outcome scenarios to the small business landscape? I mentioned a lot about AI and how it's really driving parts of the economy and something that businesses are watching out for, and certainly it's a major narrative in equity markets.
So when I think about the midterms, I try to think about what sort of scenarios would really upend or accelerate this trade. Now the base case from our politics watchers in CIO expect a Democratic House and a Republican Senate. So split government with a Republican White House.
Odds for the Democrats taking the Senate, I think, have risen over the last couple of weeks, but polling has been challenging over the last couple of years. So we're taking a more conservative approach where we're having a split government. Nevertheless, we think that this won't be a strong enough majority sweep where you'll have the Democrats having, you know, sort of the two-thirds you need in Congress to override a veto.
So the prospects for any Democrat-led AI regulation, we think right now, is quite slim. But what we do think that the Democrats can do if they have the House is much more of a legislative check on what the White House can do. It might make some parts of continuing the situation in Iran more difficult for the White House since Congress controls the power of the purse.
And if the Democrats have the Senate, that's really a personnel check on what sort of cabinet members or AI czars that the president might appoint. Having a Democrat Senate will make those confirmation hearings a lot more difficult. So it is an institutional check on what the White House can do.
That might be, so we don't think that we'll necessarily see more out of AI regulation, which will not stop the AI trade, and actually might be beneficial for rates once you have the institutional check on what the White House can do. The markets might think that the U.S. will be less profligate when it comes to spending and the longer-term rates might start to rally as a result. So mixed bag, we do think that the consensus of mixed government, split government will be the case after November, and we don't think that it'll necessarily lead to more AI regulation than when we are now, just because we still have the very likely prospect of a Republican Senate and a Republican White House.
Well, Paul, thank you again for dropping by and great catching up with you as always. Appreciate you keeping our listeners informed and look forward to continuing the conversation again soon. Thank you very much for having me, Dan.
Again, today we've been joined by Paul Hsiao, Senior Asset Allocation Strategist from the UBS Chief Investment Office. Paul joining us today to talk about the Q4 update of the ongoing CEO Macro Briefing Book Series. The latest update can now be located up on ubs.com slash CIO, though for clients of UBS, please be sure to reach out to your UBS Financial Advisor to receive a copy of the latest presentation directly.
From UBS Studios, I'm Dan Cassidy. Thank you for joining us. Thank you for tuning in.
Be sure to visit ubs.com slash studios to view the entire UBS Studios suite of podcast channels along with our video offerings, such as UBS Trending. You can also follow us on Instagram for content highlights at UBS Trending. UBS Studios is part of the UBS Chief Investment Office within UBS Global Wealth Management.
Visit ubs.com slash CIO to view the latest research. This material has no regard to the specific investment objectives, financial situation, or particular needs of any specific recipient and is published for informational purposes only. For information, please visit our website at ubs.com slash working with us.
For a full legal disclaimer applicable to the independent investment views produced by UBS, please visit our website at ubs.com slash CIO dash disclaimer. Thank you for tuning in. I'm Dan Cassidy.
I'll see you next time.
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