Taking the pulse of the US economy - insights from Washington

Welcome to Beyond the Benchmark, the EFG podcast with Moz Afzal.

Sam Jochim:
Hi, my name is Sam Jochim. I'm an economist here at EFG and I'm joined today by Daniel Murray, Deputy Chief Investment Officer and Global Head of Research. So Daniel, you recently went on a trip to the US, to Washington, which was very timely given it coincided with the US government shutdown, which meant that we had a lack of the usual data that we look at to gauge the health of the US economy. So when you were there, what was your take on the mood music out there, particularly in terms of economic activity?

Daniel Murray:
So this is a trip that Stefan Gerlach, our chief economist, and I do at least once a year, sometimes twice a year, and it's always a really good opportunity to try to take the pulse of the US economy, speak to a variety of different people and just gauge what the mood is and what the main things that people are thinking about at the time. So always super interesting. I think on this occasion, something that struck me was that historically when we've done these trips, we've got a real sense for the two or three things that people are focusing on and on this trip I just felt that there was a much lower sense of consensus about what the most important factors are. So some people talked a bit more about ai, some people talked a bit more about growth, some people talked a bit more about stock market bubble, but there was just a much wider variety of views I thought, than we'd seen before. In terms of the general health of the US economy, I just felt it was business as usual. There was no particular sense of panic, no particular sense of over exuberance or no particular sense of excessive pessimism. It just felt like it was a pretty standard environment in that context, which I think is probably a good thing despite the government shutdown.

Sam Jochim:
Great. So just picking up on two of the things you mentioned there, which I suppose are linked to each other, you spoke about AI and also a stock market bubble. I guess what's interesting is if you look at US growth this year, to what extent has that been driven by ai and to what extent is AI starting sharp in productivity numbers in the labour market, and to what extent do we expect that to continue or to pick up in the future?

Daniel Murray:
So variety of views on AI, I think I would summarise those views as generally bullish and upbeat in terms of its adoption and the potential impact it will have on the US and global economies. Although the projected impact on productivity is a little bit more nuanced and people, again, not entirely consistent in their views in terms of that. There was however a point that was raised a few times regarding the impact of AI investment spending on GDP in the first half of the year. And a couple of people noted how the vast majority of activity in the first half of the year, the vast majority of growth has been associated with investment in AI related stuff. So if you just look at the headline GDP data for example, I think around about a third of the growth in the first half years down to IT investment, there's a famous professor at Harvard called Jason Furman who's a former chair of the Council of Economic Advisors. He's actually estimated that if you look at the investment into data centres and information processing equipment, that accounts for over 90% of the growth in the first half of the year. So I think whatever that number is, certainly a lot of activity in the first half of the year appears to be associated with AI investment and I think that has a couple of implications. One of course is that the rest of the economy is probably growing much less rapidly, however, whatever you include in the rest of the economy. And so that perhaps places a slightly different emphasis in terms of the Fed's thinking and perhaps helps explain why the Fed is thinking a little bit more dovishly. I think as well is also a question of the extent to which that investment in AI can be sustained and what does that mean about capacity in the AI space. So very important but also very interesting.

Sam Jochim:
Great. So something you picked up on there was the Fed and the outlook for monetary policy. I suppose really what's interesting is that we're likely, well, we're definitely going to see a new Federal Reserve chair next year. What was the talk around that? I think there's kind of a few people that are in the running, a lot of discussion about the impact that could have on the Federal Reserve's independence and whether Trump could be trying to sway the committee. What was the general discussion about that?

Daniel Murray:
So again, there was just a variety of views. People often held, strongly held opinions on who they thought would be the next Fed chair, but there was no consensus around who that would be. A few people noted that most of the people in the running are well-educated, smart people. So even though there may be some sense that perhaps they're there to do Trump's bidding and impart more dovish policy, they are all credible in some dimensions in their own rights. So that I think is a good thing. The other point to note, of course is that the Fed is not a dictatorship. So whoever does become Fed chair won't be able to impart a policy decision unilaterally. They'll need the backing of the rest of the FOMC and they'll also implicitly need the support of the staff. So it's not as simple as Trump putting in place as chair and one of his own. That individual will still have to go through the machinations of the way that the Federal Reserve system works and the way that the FOMC works in order to get policy through. And of course it's not possible for Trump to change the composition of the FOMC overnight. It depends on the timing of the turnover of members of the firm. See that will determine the pace at which that can happen. So it's not clear cut that Trump's going to be able to influence policy that directly, although he may be able to impart a bit of a bias.

In terms of the names that we had mentioned, the three most common ones were Kevin Walsh, Kevin Hassett, and Chris Waller. I think the market's favourite would undoubtedly be Chris Waller, but it's less clear cut whether or not he would get it. Of the other two between Walsh and Hassett, it seemed pretty much 50 50. Both have their advantages and disadvantages, but again, I think both would be seen as credible. Although the market preference would probably be for Chris Waller and all the others. Michelle Bowman is also in the running and then sort of a bit of a wild card entry from Rick Rieder who's head of fixed income at BlackRock, but that seems like a very unlikely prospect.

Sam Jochim:
Yeah, I think there's going to be a really interesting space to watch next year. I guess one of the other really key things that's happened with the US economy this year has been tariffs. We saw a massive increase in tariff rates on Liberation Day in April, and since then policy moves have been quite dramatic and unpredictable. But actually if we look through to the economic data, it's unclear that tariffs are having a large impact there. What was the take on tariffs from the us?

Daniel Murray:
So I think the first point to note is that when I was last in the us, which was in early May, that was all people were talking about. Tariffs was the only subject on the agenda, huge amount of uncertainty because it was shortly after liberation day and lots of people struggling to make head or tail of what the impact would be, but generally the mood was quite negative around tariffs and that it was going to result in a big hit to activity and result in inflation being stickier. I think if you fast forward to today, and it was much lower down the agenda of topics that people wanted to talk about. So I think that's quite telling in and of itself, and obviously the data in the US so far this year has remained reasonably robust. I think that, and as much as we did hear a view about tariffs, something that came up a couple of times was the fact that companies have been able to delay the impact so far.

There was a lot of front loading of activity in the first half of the year, so companies brought forward imports, they stocked up on inventory ahead of liberation day in anticipation of tariffs and they've been using that inventory to supply the market between then and now, but that their ability to do that is now much more limited. And so a couple of people talked about the possibility that we're going to start to see the impact of tariffs get pushed through to consumers in the months and years ahead. The general view was that this wouldn't be a sort of sudden sharp shock, but the impact would be implemented step-by-step over say the next one to two years. So there could be quite a long tail to its impact, but it was felt that it wouldn't be a sudden shock, which I think is probably a good thing, although it will of course tend to push up inflation. I think the downside risk to this is that the higher pricing that might come about as a result of tariff push through could of course negatively impact the consumer. So that of course also has implications for monetary policy. The other point that some people noted was that we started the year with profit margins quite high, and so something else that's been a contributory factor is that companies have been able to absorb the impact of tariffs via their margins. So super interesting.

Sam Jochim:
Yeah, and I guess one of the things that we've spoken about this year is the potential offsets to tariffs. One of those we've noted is the one big beautiful bill act, but on the flip side of that, we have to then think about the trajectory for the budget deficit. That's something the markets have really been focused on this year in the US and I just wanted to kind of gauge the mood music actually out there on the trajectory for the budget deficit and how key an issue it is for people there

Daniel Murray:
Again, it wasn't a particularly hot topic. I think with regard to tariffs. It was noted that the revenues from tariffs are currently running at something like 30 to 35 billion a month. So if you annualize that, it's somewhere between three 50 and four 50 billion a year. So that's very nice revenues. So I think that whoever gets in and the next administration is going to those revenues, that's going to be quite difficult to wind back the tariffs without trying to find additional revenues from other sources. So that was something that was noted. Also, it was noted that of course there's increased uncertainty about tariffs in the context of the upcoming Supreme Court decision, and one of the fiscal implications there is that they may have to give some of the money back. It's not exactly clear how they would do that, but I think that creates a mess and more fiscal uncertainty.

I think something that has been talked about is that the Trump administration could invoke something called Section 899 as a means to tax foreign payments related to treasuries. This was thought very unlikely it would amount to a technical default. So it is possible, but the general view was that the Trump administration wouldn't do that. So I think overall no great sense of panic about the fiscal situation. Obviously everybody knows it's there and it's the sort of elephant in the room, but hopefully it won't cause any panic in markets and you do have this nice partial offset because the tariff revenues are probably exceeding expectations at the moment.

Sam Jochim:
Great. So I guess if we kind of summarising then, are there any key risks that you think about with the US economy next year that we've not spoken about or that were brought up in your meetings in Washington that don't get such large media coverage as the other issues we've discussed today?

Daniel Murray:
I think we've talked about the main point. So I think this issue over delayed impact to tariffs is probably the main risk that people were talking about. I guess there's also implicitly a risk that this AI unwind has an impact that if these investment levels aren't sustained, then growth is just much lower and that will clearly have second round impacts for the economy more broadly. And I think of course there's always the risk that this incipient and rather gentle labour market weakness that we're seeing in the US, which is nothing to worry about at the moment, pretty, it's in the context of labour markets that remain pretty strong in aggregate, but there is a risk that accelerates for some reason. So companies perhaps you can imagine a situation where the Supreme Court rules the tariffs illegal, that creates more uncertainty, companies then defer and delay hiring decisions, they defer and delay CapEx decisions.

And if a sufficient number of companies do that in aggregate, then that creates a negative macro impulse which could cause a recession. So I think the problem with recessions is they're always very difficult to spot in advance. You never know what's what, but that is a possibility. Something else we did discuss with a couple of people was private credit markets, and that's clearly a hot topic as well at the moment, and that would've a risk to markets and by implication a risk to the economy. But I think in as much as we spoke about this with people, the general mood was that there was no sense of panic and that as much as there was information on it, it didn't look as bad as perhaps some of the media reports were suggesting.

Sam Jochim:
Great. Thanks very much, Daniel. There's some really interesting points you raised there. Sounds like you had a very fruitful trip to the US with some great discussions. So that wraps up this episode of Beyond the Benchmark. Thank you very much for listening and we look forward to you listening into future podcasts.

 

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