So I say good morning. This is what's going on. Trump says he'll pay American voters $5,000 for a Republican win in the midterms. Iran says it's ready to escalate the war. There's been a muted reaction to both stories in Treasuries, but yields are higher, of course testing Scott Bessent. And the ECB is on tour; it's in Berlin. It's almost certain to deliver another hike, but is that it, or is there more to come? Lots to talk about this morning then, Guy.
Yes. Yields have been higher over a longer period. But looking at what's going on in markets, pretty muted response, as you say, to what we heard from the president about giving money to American voters. Will that last? Does that reflect the policy itself, or is it about doubts that it will ever come to pass? European gas futures look like this: we've been over €80 a megawatt-hour in the past 24 hours. Does that have more to do with Russia than what's happening in Iran? And this is the picture on European stocks. It was a pretty bleak, bleak day for European stocks yesterday, partly because of that higher gas price, higher energy prices—Brent over $100 a barrel in yesterday's session, of course. But European stocks suggesting we should get a little bit of brightness at the start of trade this morning. The countdown to the opening trade starts right now.
So the US Treasury Secretary, the US Treasury announcing and outlining the plans: $6 billion, that is the number for the buyback at the long end, triple the original planned number. But bonds sold off yesterday. Treasury yields edged higher. It turns out oil at $100 a barrel and a president who wants to spend north of $1 trillion to win over votes is more of an impact than a Treasury Secretary determined to buy at the long end, even if this doesn't come to pass—$5,000 per American citizen. It tells you something about the president's instincts, and that is a factor for the bond.
I think that's the most important part of all of this. This is highly unlikely to come to pass, though other countries have done it and other presidents have done it. It is the fact that he clearly has no interest in bringing down the deficit, clearly has no interest in bringing debt under control. I think that's the message of the market.
Yeah, that's the important instinct, as you say, the important messaging around his thinking that maybe we need to know. Because going back to Scott Bessent just weeks ago, wasn't it we heard from Scott Bessent when he initially unveiled these plans to intervene in the bond market, and that there'd be some attempt to bring down the fiscal deficit, there'd be some fiscal action that he'd been charged along with others to do that? But there's been quiet on that front. We haven't heard any more about that. And that, at the end of the day, is the thing really lifting bond yields at the long end. And so everything that Scott Bessent was talking about—well, the Treasury has been talking about recently about that intervention at the long end—according to those in the market, unlikely to have a long-lasting impact if it's not combined with action to bring down the deficit.
It doesn't look like that's going to happen. Maybe if you get a split Congress, maybe if you get split government in the United States, maybe there's some deal that gets done. But I can't see that happening in any meaningful shape or form. It's really hard to bring down spending.
Yeah, like a lot of it's mechanical, right?
Indeed. And it is one way to think about whether we get a split Washington after the midterms or not, because the prediction markets and the polling suggesting that it's going to be very difficult for the Republicans to hold on to the power that they have, and the prediction markets even suggesting we could see the Democrats take both houses. And so maybe that's relevant when we're thinking about whether President Trump is really going to give away more than 1 trillion USD. Does it—I mean, does it smack of desperation? I mean, for many, that will be the key takeaway from this as well outside of the markets, is this smacks of desperation as you look at the poll numbers for a Trump administration and the Republican Party that, on the polls, look like they're going to get a shellacking in the midterms.
Everything, it seems, that this administration is doing is leading up to the midterms: wanting to run a hot economy and wanting to get the money into the pockets of voters, or at least promise them that, even if it's difficult to see how that comes to pass. If they were to find a mechanism to get it into pockets of consumers, good for equities, bad for inflation.
Yeah, very bad for inflation. That, I think, is probably the biggest takeaway from all of this. That's certainly what we saw coming out of COVID.
Let's talk about something else which potentially could be bad for inflation. Oil remains elevated north of 100. The Iranians are talking about the fact that they may look to escalate. The Republicans, back to the American politics story, are looking maybe that this story is going to be a feature of the landscape for the whole of the Trump presidency, and therefore you've got to start thinking about how you price that in for Europe. What does it mean? High gas prices. I know gas prices were a little lower this morning, but they still feel quite elevated, and it doesn't feel like we've got much of a buffer going into the winter. We don't feel like we've got many governments here in Europe that can protect consumers.
Yeah, I think that's interesting. The Wall Street Journal had that report about Rubio and Vance both raising the prospect that maybe the Iran conflict goes to the end of the Trump presidency. And so I'm interested in whether our guests are starting to price in disruption over that kind of time period and what that means. But interesting to see where the disruption comes from and what moves markets, because yesterday we saw those gas prices in Europe go over €80 a megawatt-hour. And it actually seemed to be—it was hard to pinpoint exactly what drove it, but it did seem to be a little more to do with Ukrainian attacks on Russian energy infrastructure than it was to do with what was going on in Iran.
The reframing of timing is so important. The Trump administration said this war would be done in weeks. It was consensus amongst our guests that this would be a deal ultimately, and probably before the midterms. That's not happening. Now we have The Wall Street Journal suggesting that JD Vance and others, Rubio, are thinking about another two years plus of this conflict. Talking about here in the UK, what do we have? 12 days of gas storage in the UK in terms of what we're able to actually keep onshore because we're so reliant on those everyday flows into the UK—12 days on average of a winter supply versus 3 to 4 months in Germany.
In Germany, it's always been a huge difference. We've never had a lot of gas storage here in this country. It's never been a feature of the landscape in the way that it has been maybe in places like Germany. So this is not a new phenomenon, but it just highlights once again that we are going into a winter where you don't have that ability to manage prices without some sort of government intervention into the market directly. And that is, again, something that's going to weigh on the budget as we approach it, as we think about it.
Yeah, it makes life difficult for the UK government, also making life difficult for policymakers who are trying to set monetary policy. Let's talk about the ECB on tour—not very far from their Frankfurt home, but they've got as far as Berlin. So they have some small talk. Will we get the second hike since the start of the Iran war? That's very likely. That seems to be the expectation today. We'll also get new forecasts. But really, what comes next is going to be really important because there's a lot of divided opinion here. And how long the conflict in Iran lasts will certainly be an important factor here. So we see two-plus hikes after this one priced in by markets—more than two more after today's hike, which is expected. But economists are kind of skeptical because if it's all about energy prices, if it doesn't really show up in pass-through into core inflation, if we don't see second-round effects, then how many more hikes are we really going to get from the ECB?
And so with that in mind, it'll be interesting to watch what they are saying is going to happen to their inflation picture, which will be the second-round effect as they operate with a lag. And Europe has a highly structured labor market, which means that you're going to probably see this showing up at the beginning of next year as we start to get into the wage rounds in places like Germany.
The ECB, in theory, you've got to front-run that. So you've got to get an idea of what is happening and you've got to make a decision around that. Or do you wait for those second-round effects to show up? If they've already shown up, they're very sticky and they are going to have a big effect. So the ECB is in a really tricky position here at the moment. It's only got inflation as its narrative. Does it have to assume that if energy prices go up there is going to be a wage effect? Or is there enough slack in the labor market to mean that there probably won't be? This is the central bank that has the most credibility at this point, because it actually got inflation down to 2%, inflation now back up to 3%. So the pressure is on if it's not today, then going beyond.
Yeah, maybe there's a lot of slack in the economy in Europe in a way that there isn't in the United States, where they're running the economy a lot hotter. Do you know where else there's going to be speculation? Christine Lagarde—is she still going to be here? Is she still going to be in post this time next year? Read the book.
Read the book! She's written a book, it's out in January, isn't it? And we have some colleagues reporting that the World Economic Forum is still trying to court her. So we will see if that gets a mention in the press conference.
Yeah, she said she will go where her talents are best used or something. French politics again? She's been there before though, so maybe she'll take French politics.
We have lots to talk about. We do have lots of great guests. Lauren van Biljon is going to be joining us, Allspring Global Investments senior portfolio manager. Ludovic Subran, Allianz chief economist. Sebastian Raedler is going to be joining us, Bank of America Research European equity strategy head. Amjad Masad, CEO—we're going to talk about vibe coding. Is that the case a little bit later on?
Vibe coding, yeah. Build your own apps, software, etc.
And also AI risks, because there's been a lot of focus on that as well. So we'll get that take from that CEO on what's happening and some of the risks around AI as well. Let's look ahead to what else we are thinking about throughout this Thursday. 11:00 a.m. UK time, OPEC's monthly oil market report will drop. Of course, that will be salient. At 1:15 p.m. UK time, we do get that ECB rate decision, almost entirely fully expected to hike, of course, 25 basis points, followed by Lagarde's press conference that we will bring you, of course, live—that's at 1:45 p.m. UK. At 1:30 p.m. UK time, we get producer prices out of the US. That's a drum roll ahead of CPI consumer prices tomorrow, of course. And President Trump and Vice President JD Vance will be speaking at the Republican midterm convention. So we're going to be hearing more from the US president after that $5,000 promise. And on the US earnings front, Oracle and Adobe aftermarket.
Yes, indeed. We will get to that. Lots of tech things to talk about as well, and one of those is around Apple that's coming up on the program. Apple unveils, unfolds its first foldable iPhone as the new CEO John Ternus takes center stage. We will unpack that in the context of AI, of course. Plus, one of Africa's biggest banks, FirstRand, is set to report results this morning. A key focus will be on the firm's planned exit from the UK market. And what do the big movements that we've seen in global bond markets mean for running this bank? We will bring you that conversation with the CEO of FirstRand that is set a little bit later on this morning. Up next, we'll be joined by Lauren van Biljon from the global fixed income team at Allspring Global Investments. Please get involved in these conversations. We do like to hear from you. IB plus BTV GO is the functions you use on the Bloomberg terminal. This is Bloomberg.
So if the Republicans win, you win with us and you get $5,000. It will be called the Trump dividend. The only caveat I have is that the dividend that we're making must be spent in the United States of America.
President Trump speaking overnight European time at the Republican midterm convention in Dallas, a fairly unusual affair in a midterm year. President Trump's offer comes as Republicans battle to keep control of the House and the Senate in the upcoming midterm elections. For more, let's get analysis with Bloomberg's... So we heard President Trump there talking about how the payments should be spent. We didn't hear much about how they would be funded, and I guess that's what bond markets will be a little bit worried about, although not moving all that much right now.
Yes, I hate to disappoint, but unfortunately we don't have a lot of details in the way of how this handout might be delivered, how it would be funded. It is well over $1 trillion that would be added presumably to the US deficit, so Congress would have to approve it. But based on the market reaction—and markets have been very, very concerned about the US deficit—there's not a ton of conviction that this will actually happen. There wasn't a huge reaction in the markets to this announcement. So that brings us back to why Trump is saying this, why this event is being held in Dallas right now, which is the reason is that the Republican Party is behind in this election, and they feel like they need a big bang. Trump feels like he needs to put himself at the center of the attention of this election. This is one way of doing that. The other way of doing that: he said it very clearly, 'Pretend that I'm on the ballot. Vote for me in this election.' He thinks that putting himself into the center, which has been his MO since he entered politics, will be his best path toward retaining control of the House and the Senate, because he knows that if the Democrats gain control of one of those houses, he will be in a lot of trouble. He will be, in effect, a lame duck president. So what we see here now, they're trying to roll out this kind of big policy, something that everybody can understand very clearly—a quid pro quo, if you will. 'Vote for us, you get $5,000.' It's a very easy message, very simple message for this kind of final stretch of the election campaign, where again, the Republicans are running from behind.
Yeah. The market's not listening. You wonder whether the population will be listening. Thanks very much for updating us on what we've heard overnight out of Dallas. Though Trump's $5,000 offer risks adding pressure to Treasuries, you haven't seen much of that so far. This is the yield we currently have across the curve in the United States. It does, though, maybe deliver a kind of broader message, which is: I'm not that worried about government spending. Lauren van Biljon, senior portfolio manager on the global fixed income team over at Allspring Global Investments, joining us now. Good morning. I know most people don't believe the policy, and that's putting the politics to one side, whether he delivers this or not, what will happen in the midterms, I don't know. But the message—the message to the Treasury market is: we're going to keep spending. At some point again, is that a negative for the Treasury market? Is that just another factor that's going to drive yields higher? What should we take away from this?
I think what we take away from this is that there's no appetite for fiscal discipline really in the US. But on that more global stage as well, deficits are fairly high, and that might not be deteriorating, but there's no appetite to improve them. And as yields rise, that does affect what the interest payments are for governments. But the one perhaps bit of good news when you look at that equation is that nominal growth has improved so much the last 18 months, and nominal growth above that cost of funding is actually not too scary for bond markets.
I'm running a kind of 8-9% nominal growth at the moment. If you take a look at some of the nowcasts, right, it makes US yields look like good value.
When we get to 5%, could it be tomorrow? CPI is out tomorrow, we've got PPI out today. What are we watching for?
I mean, yeah, it's a nasty CPI number and it's a big miss to the upside. If these bond markets are capable of going 10-plus basis points in a day, we saw that yesterday across maybe not the US, but... Now things are moving really, really quickly. So for a bond investor, it's time to be pretty tactical. Don't get too wedded to positions and try to be as nimble as you can on these sort of when you think the market is going to look an extreme in either direction.
You think there are opportunities then in bonds? Where do you land on that?
I mean, bonds right now are offering you an incredible income, right? That reset has been material, and capital gains have been harder to come by, at least in a kind of over a six-month period, although there's the shorter kind of six-eight week periods where it works. But if you can buy a bond for that income and that yield, it is an attractive proposition.
Would you want to be buying hyperscale investment grade over Treasuries, for example? Is that a better bet? Is that a less risky bet?
Well, perhaps you talk about diversification. You say that hyperscale supply has been material, right? And we have seen some movements in that very long end, right, people lining up on government bonds to buy some of that hyperscale debt. So I think it is about diversification and just actually locking in these yields where you can, but trying to be careful with the total amount of risk you're taking to any one name.
Lauren, what was your response to what we heard from the Treasury yesterday in the States about the buyback, the size of it? We got the notification yesterday, the action comes today. The markets seem to be disappointed. Yields shot up, which was not the design. It's not supposed to have that effect, I imagine.
No, definitely not. I think the market was hoping for a little bit more, you know, I think probably more on the 10 billion mark than the 6. But also it was coming on a day when global yields were higher, right? Oil up, natural gas up, some more negative headlines on geopolitics between Iran and the US. With that backdrop, no matter what the buyback number was, it was going to be difficult to rally meaningfully.
We have a Treasury auction today, 30-year, very long end. That's where a lot of the nervousness has been around the fiscal story. So on the back of what happened yesterday, the disappointment on that Treasury news, the president announcing money that we don't know where it's going to come from, and maybe the bond markets if they took it seriously could get nervous—does this mean, and we have minutes ahead of CPI, are you a little nervous about this auction today?
It's going to be a great one to watch and see kind of where the book sits, how much of coverage we get. I think the UK 30 earlier this week had incredible coverage—almost 20 times books versus what else. That yield, that level of yield can be attractive for the right buyer. So people aren't stepping away from these markets entirely, but they are being more thoughtful about what level they buy.
Not attractive enough though, because these yields keep rising.
They keep rising, yes. But if you can buy now and your holding horizon is a couple of years, do you mind if you miss out on the last little bit of that move?
The market is still functional, which is interesting.
And there's not this kind of breakdown, which would kind of take you to the backstory of why you would need to maybe do that. In terms—I hate to echo a colleague, but I'm going to do this from our live team—he thinks that Europe's the bigger problem. We're all focusing on Treasuries, but as you highlighted, big moves yesterday in Europe. Is this where the issue really lies in terms of the high yields and the impact they're going to have?
Yeah. So Europe doesn't have that nominal growth versus cost of funding. That number does not show in Europe, typically somewhere like France. Europe, the big growth has surprised on the upside the last month or two. Looking at that August PMI, right, services manufacturing were accelerating a little bit coming from new orders. So I think the inflation side in Europe, we know they're more exposed to oil and gas. We know that those prices are looking more stuck where they are, which kind of introduced the idea of persistent inflation. But it does have effects on growth, at least if there is growth at lower levels.
This graph is interesting that Mark wrote about, you being more worried about Europe. Yesterday we spoke to Gareth Morgan, who was more worried about the US than Europe. There are lots of different views out there around where this pain really crystallizes. A 6% deficit in the US, $40 trillion, and yet you have that growth. Growth at a more moderate rate, of course, in Europe, and deficits slightly narrower. At least here in the UK, most parties, including arguably Reform as well, acknowledge that there needs to be fiscal discipline. That's not necessarily the case in France. Does France become the problem child in 2027?
It's kind of the problem child right now, right? I mean, the way spreads have moved. And I say that as someone who has exposure there. I think there is some value there, but it comes with a lot of noise.
What is your exposure and what would lead you to unwind that?
We've been back to following the kind of short end of these curves. I think that very long duration is just not attractive almost anywhere. So it's been more like 2 to 5 area of the curve. What I think is interesting is, does that 5 to 10, that 7 to 10 years start to become more interesting as the ECB continues to tighten and we start thinking about the yield curve that is flattening? So maybe that is an argument that you look at extending duration of some of these markets into 2027.
I'm glad you brought the ECB into it because we haven't touched on it. Of course, its rate decision today from the European Central Bank, but we'll get more analysis on that of course through the show. Lauren van Biljon, thank you very much indeed. It was great to get your insight. Senior portfolio manager in the global fixed income team at Allspring Global Investments. What else do you need to know this Thursday morning? Let me walk you through it. JPMorgan CEO Jamie Dimon has met with UK Prime Minister Andy Burnham and his Chancellor, John Healey, in London. Sources say the Wall Street top banker visited Downing Street yesterday because the new government was imposing a windfall tax on bank profits. Burnham's predecessor, Keir Starmer, resisted calls to increase the tax on the banks, but Burnham has so far declined to rule out that option. Healey will deliver the first budget on October the 28th. We're planning some great coverage around that. Porsche says it will generate around €1 billion from selling its stake in the joint venture that owns Bugatti, Porsche majority. And of course, Volkswagen has raised its full-year net cash flow margin forecast as a result of the deal. It's part of a broader push to streamline the Volkswagen portfolio in the face of waning sales in China. And Apple has unveiled the company's first foldable smartphone, betting that the new category can energize growth for its biggest-selling products. New CEO John Ternus says the device, called the iPhone Duo, will improve on rivals' foldable models. The device will sit at the top of Apple's iPhone lineup, with a cost that starts at just below $2,000 and reaches beyond $3,000 for the top model. The folding phone wasn't the story for me yesterday, though. The folding phone kind of came second to the fact that they're raising prices quite aggressively.
Yeah, once again, they've done this already and they continue to raise prices. And this is the inflationary impact of AI. There's not much AI in this story either, but the inflationary impact of AI is coming through because they have to raise prices because components are getting more expensive.
That's where your focus was on the macro. Probably rightly so for a show like this. I was focused on the watch, which can now record your conversations through the day.
Great. I don't know how you feel about that.
Does it light up like the glasses supposed to have a little light on them to tell everybody around you that they're being recorded?
Yes, yes. But with this, you can scroll back and listen back to conversations you've had in case you forget something. Actually, that could be useful.
That could be very useful. I forget a lot of things. That could be very useful for me during this show. And I was interested in the fact that this is another example of not being first to something, but raising the question of whether they'll do it pretty well. I mean, people say that about Apple and AI, and John Ternus is trying to set these new products in the AI context, which I thought was also interesting.
The crease in the middle—you can't see the middle on some of the Huaweis. You can really see the crease in the middle of this one. Apparently, it doesn't happen, but will it crease there if I have it for a year? Crease three years' time? How long do these people have with the test? Maybe that's a test coming up.
Markets pricing in a hike from Apple iPhones to the ECB later today. We'll discuss the current economic outlook with Allianz CIO and Chief Economist Ludovic Subran. That conversation coming up next. This is Bloomberg.
Morning. What's going on? 7:30 in London. Let's take a look at what we're seeing in terms of the futures picture. This is what we are watching. You are looking at an empty market that doesn't look like it's got a lot of gas to it this morning, though at least you could argue positive when it comes to stocks. The stock safety features—there's quite a lot of events coming up. So you've got PPI out today, you've got CPI out today, and of course we'll get to the ECB in just a moment. So there's a few things that are worth paying attention to this morning.
Absolutely. And both markets will certainly be watching that ECB meeting, also reflecting on what we've heard from President Trump overnight. Bond markets listening, maybe not taking it all that seriously, the money that he plans to give away if he wins both houses in Washington. So we'll watch US politics, we're watching the ECB, all of that very influential perhaps on these bond markets. But we did see bond yields actually spike considerably yesterday on those higher gas prices.
Yes, a modest reversal of that selloff that we're seeing today. To your point, the ECB of course set to hike interest rates for a second time since the Iran war and energy prices soaring, leaving inflation locked well above that 2% target. With a quarter-point deposit rate rise all but certain, investors will be watching closely for hints on the rate path ahead. Let's bring in Bloomberg's chief Europe correspondent, Oliver Crook, who is in Berlin where the ECB is meeting today. We know they're going to hike essentially, Ollie. What else are ECB watchers going to be focused on today?
As you say, Tom, the hike is basically guaranteed here. If you look at the market pricing, there's a 102% chance of a 25 basis point hike, which would bring the rate up to about 2.5%. And of course, we'll be watching very closely the forward guidance in terms of whether there will be another hike, will it be in December or will it be in February, and all of the different inputs that are going into the ECB thinking. We'll be watching very closely that press conference with Christine Lagarde a little bit later today. But thinking about the situation now, this hike was basically a foregone conclusion because of what we saw in terms of the inflation picture. In the month of August, it reached 3.3%. If you break that down and look at what has really been driving the inflation, the main protagonist since the very beginning here has been energy prices. And when you see oil going back over $100 a barrel, you see the price of gas in Europe the highest that it's been since January of 2023, you really see that energy story sort of accelerating into the wintertime. And of course, as it gets colder, those gas reserve levels are very, very low in Europe by historic standards. That is going to be the main driver here. That being said, you think about the difference between the hike today versus the hike two meetings ago. There was really only one protagonist in that decision, and that was the energy market. Here you have another protagonist, and that is the bond market. You have those yields climbing up across Europe, across the world. You have those credit conditions really restricting across the eurozone. That is going to be a concern for the European Central Bank. That's sort of countervailing some of the inflation pressures that we're seeing in terms of what the calculus is for the ECB. So thinking about the future in terms of what comes next for the ECB, we're going to be watching very carefully, obviously, those forecasts, what the ECB is going to do. But we should say that that 25 basis point hike that takes us to 2.5%, that is really seen at the top end of the neutral rate for the ECB. So after that, the bar is going to be very high because it really starts to push you into restrictive territory when you start raising potentially in December or February. So again, we'll be watching the balance of risk when we hear from the Governing Council a little bit later today.
Ollie, is this an ECB meeting or is it a book tour?
Well, that's a big question. I think that Christine Lagarde is going to get a lot of questions. As we should say, she's been getting a lot of questions over the last four months in terms of what her intentions are about whether she's going to stay for the full term as president of the ECB. Her term expires in October. The sort of feeling is that she will probably leave early next year. The fact that she's putting out this autobiography, again, likely in the beginning of next year, sort of conspicuous that she may step back from the ECB, may take some kind of role in the political picture over in France ahead of the election, but also giving a free hand to Emmanuel Macron to have some influence on who is appointed to the ECB as president after her. In terms of the front-runners, we know right now it's the Spanish de Cos, who has been put forward by his government and endorsed by the Dutch as well. Also been put forward officially, there is a question about whether Friedrich Merz, the Chancellor of Germany, will put forward the Bundesbank president, Mr. Nagel. So these are all sort of the names that are swirling. But if we think about the path forward for the ECB, if you get the next rate hike potentially in February, that could theoretically be presided over by a new ECB president. And that is going to be when things are a lot more delicate in terms of the ECB raising rates and not wanting to sort of stoke that stagflation dynamic of that higher inflation, but then that growth being reduced by those tighter and tighter credit conditions and higher yields.
Ollie, thanks very much. Oliver Crook in Berlin on the trade at the ECB and Christine Lagarde on her future career plans. All of that in focus as we bring you full coverage of the ECB rate decision throughout the day at Bloomberg. The decision coming at 1:15 p.m. UK time, and President Lagarde set to deliver her press conference at 1:45 p.m. UK time. To talk more on Europe's economic outlook, let's bring in Ludovic Subran, CIO and Chief Economist at Allianz. Ludovic, good morning. As we think about that expected hike tonight from the ECB, where do you think the neutral rate is and what do you think the deliberations will be? Is it going to be the focus on second-order effects? Are you seeing any signs of that? And where are they landing on neutral?
The first answer is no. Good morning first. No, we don't see any second-round effects at all. Look at the situation in France, for example, where we were borderline recession in the first half of the year. Germany is slightly recovering, but it's very fragile. So I don't see any second-round effects. Core is actually down a bit. On the second question, where do I see the neutral rate? It's a good question. I do believe if the ECB hikes again before the end of the year, they will have to cut twice in the first half of 2027. So I do believe you don't change the neutral rate somewhere around—I don't think they can be much above 2.5, 2.25. So I do think that it's two up for two down because the financial conditions, as Oliver explained, are tightening. And right now it's an energy price doom loop. So I don't think this has changed. In the US, it is very different, but we don't have so much growth picking up. The real rate is not picking up as much. So I would be very careful that we get into tricky danger territory towards the beginning of next year.
And that's where we would be if they didn't cut twice in 2027 if they hiked twice this year. Is that because higher yields are doing part of the job for them? Is it partly because the higher energy cost is squeezing consumers? Just explain that view for us.
I think it's mostly an energy story. That's why there is a bit of this mini tightening and loosening cycle. It just mentioned that they're going to hike twice and then going to cut twice, which is something that is a bit new when you have this sequence of very severe supply shocks. But I think that's the new normal for monetary policy. I do think the bond market is doing part of the job, especially on—you see that in real estate, you see that also in the loans at which companies get borrowing terms, which are not very good. So this is clearly also cooling down a bit some of the investment that we see in the economy, which is also something that they should be watching. So somehow I do believe that right now they just need to do preventive hikes because of the gas price, which is particularly high. And we see the situation is not getting better in the global energy market either. And everybody's concerned about China going back to replenish their reserves on anything energy. So I think they have to do these preventive-type cycles because of 2022, which is a PTSD for the bond markets. But this is giving this impression of stop-and-go, which I think is very hard to swallow for the real economy, if you ask me.
So it's a mistake. Like two hikes, two cuts—that's a mistake, right?
I don't think it's a mistake at this point, or at least we don't see the signs of the mistakes. But I do believe this is something that is going to be an overhang for growth and carryover growth into 2027, for sure. I'm pretty sure this is going to be casting some of the necessary growth that Europe will need into 2027.
What effect will the two hikes have? This is the bit that I don't understand. Like classical economics: you look through a supply-side shock. You can't control it. You're a central bank—you can control aggregate demand in your own economy, but you can't control it outside. So why are you hiking? Why has the ECB hiked twice when it doesn't have the growth, the demand to justify it?
Well, it is really because you have everywhere in the world, and especially in Europe, you have this situation where governments are piling up all of the liabilities and the private sector has record-high savings, and the companies are booking record profits. So the main concern that everybody has is that if they don't hike, there is still aggregate demand that is going to contribute to fueling this second wave of inflation, which is not supply-side-driven inflation, but this is monetary inflation. And yes, in Europe we have a very strong bias against any form of monetary inflation, which is the main difference with the US, where you actually like a bit of monetary inflation even to give the nominal signal for your CapEx investment. The problem we have in this continent is that we don't want this nominal price signal for investment, and this is what is costing growth two or three quarters down the road. So right now it is really preventive, as if people, because of their savings, would continue to consume in spite of—would continue to take some form of loans in spite of the borrowing conditions that are tightening. And that's basically this preventive hike. Is it a mistake? No, but it's clearly very doctrinal.
So let me just linger on this for a moment. You think this is preventative because it's aimed at getting ahead of second-round effects which are not visible yet, but would come?
'Would come' is the right auxiliary, okay. Because I think the second-round effect on the market, we don't see it, to be honest, on the wages. So it is really the second-round effect as if demand still holds on because of, let's say, the fact that people have savings.
Okay. And what does that do to investment then in Europe? What does that do to the AI buildout and CapEx and the things that are booming elsewhere?
This is, I think, the biggest cost. That's why I think it's going to cost us, because you need so much investment into the new economy, let's put it this way. And for that, it's true that cheaper borrowing costs are definitely a competitive advantage. Cheaper energy costs also, cheaper labor costs also, but cheaper borrowing costs are a defining factor. I think in the US you still have enough of a wealth effect almost, and also aggregate demand. You also have very profligate fiscal—even more profligate if President Trump does the $5,000 check for Americans, but let's put that aside. I think there you can swallow the higher borrowing costs. In my region of the world, I think that would be a drag. And so our expectation is that this will actually have a negative effect on CapEx by almost 1 to 2 percentage points. So it will erode the potential for investment for Europe into 2027 because we go to 3%. That's why we need to stay at 3% a very short time; it needs to be a transition. Otherwise, these effects will be visible. That's why I expect the two cuts, because you need to go back closer to the neutral rate at 2.5. Otherwise, I think a lot of people would just not go for what they think is the right investment today for AI production and adoption, that's for sure.
So AI gets hurt. Can I just come back to why you think the ECB is hiking? You think the ECB is hiking because of the huge savings rate that exists in Europe. Can you explain a bit more the effect of higher energy costs on that savings rate and why that savings rate is important in terms of why you need to deliver these two hikes?
I think it's mostly an inflation story. But if I look at the broader picture, I still look at what's happening on the exchange rate, of course. But I think for me right now, the main reason is they continue to see that there are reservoirs of demand that are particularly replenished today, which are in particular the savings from households—20% savings rates in Germany, 18% savings rate in France—and also corporates that are doing quite well. And so for them, it's this idea that in spite of the energy shock, they don't see growth yielding to the pressure. And so this idea that even with high energy and food costs, people will continue to accelerate prices. And then you see the inflation from a very secluded area of the world, which is energy and food, basically going into services because of CapEx and into other sectors. And that's the thing that they want to break, because then they know that it is self-reinforcing. I still believe it's very cautious not to do it, because right now that's not what we see. We actually see people increasing precautionary savings because of the concern over the outlook of social protection reform. So we don't see this effect of savings magically going into the equation, into consumption and boosting demand artificially. So that's why I say that's what I think they think, but that's not what I think would happen.
Yeah, so the behavioral economics out of Michigan, etc., their kind of theories on behavioral economics probably holding at this point. Ludovic, great to see you. Thank you very much indeed. Ludovic Subran, Allianz CIO and Chief Economist. Let's talk a little about what's happening over in the United States. We were just mentioning it. The Trump administration says energy flows are increasing through the Strait of Hormuz.
We're at the highest since the start of the conflict, just under 11 million barrels a day seven-day average of oil and oil products going out of the strait on ship on water, and then another 3 to 5 million barrels a day from the bypass pipelines. So we continue to grow the oil and oil products coming out of the Gulf. The American Navy is doing a phenomenal job there, so a lot of good progress there.
