Weekly Market Recap

The biggest controversy in finance at the moment relates to the strength of the AI trade. The latest chapter in that story has centred around the longevity of the so-called ‘picks and shovels’ plays – investment strategies that target the companies providing the tools, equipment, infrastructure or services an industry needs to operate. In this case, that means semiconductors and the associated ecosystem.

AI models could establish monopolies, or they could be highly competitive.

If it’s the former, the benefits of AI will accrue to them. If it’s the latter, prices will fall and the benefits will accrue to their users. Regardless, there’ll be a lot of infrastructure built to serve these masters.

Now, there are constraints to that build-out. Political opposition to data centres has been growing due to their impact on local electricity prices. The funding available for new data centres has also been dwindling. 

This is due to the available cashflow of hyperscalers (large cloud computing firms) being fully deployed, and technology and consumer services becoming the second and third largest sectors in the investment-grade bond universe (and amidst the highest yielders).

The argument about AI spending was conducted at unusual volume last week and it began with an unlikely critic. Broadcom’s Chief Executive, Hock Tan, likened some AI investment to betting in a casino, questioned whether the developers of frontier models can make money and observed that genuine productivity leaps remain scarce, while most companies are still experimenting. 

That’s candid talk from a business whose own order book depends on exactly that spending. As a chief executive with a track record of colourful commentary, this probably wasn’t the driver of the semiconductor correction, but the remarks certainly capture the mood.

The Philadelphia Stock Exchange Semiconductor Index, the SOX index, which has become the bellwether for the theme, fell more than 10% in just over a week. Meanwhile, SK Hynix, the Korean memory giant, has fallen 30% in a fortnight.

The counterevidence came from the companies that sell the equipment and make the chips. Advanced Semiconductor Materials Lithography is supply-constrained rather than demand constrained: tool supply for 2027 is unchanged and 2028 offers limited upside, which disappointed some. Yet, its installed base business, which maintains machines and provides recurring revenue, grew 70% over the year.

Taiwan Semiconductor Manufacturing Company (TSMC) raised its revenue growth guidance from 40% to 44% in dollar terms for 2026. Third-quarter revenue rose 40%, which was driven more by the richer mix of AI wafers than by volume. Capital spending of USD60 billion to USD64 billion looks likely to land at the upper end, with roughly 20 fabrication plants (fabs) under construction worldwide, as well as a possible new cluster in Texas. Discussions with Elon Musk’s TeraFab venture are also underway.

We are also interested in what this implies about the shape of the cycle. Semiconductors have historically been violently cyclical, with upswings traditionally driven by a single product category, first the PC and then the smartphone. The demand base is broader now and the fabs being built today take years to arrive, which argues for a longer and smoother cycle.

TSMC has typically been conservative with capital. Its commitment speaks louder than its commentary.

So, industry fundamentals look solid and valuations have fallen, mostly by companies growing into them, but over the past couple of weeks, share price falls improved them even further.

AI’s claim on real resources is also starting to show up where investors feel it most directly: in prices.

Dwindling disinflation

Underlying U.S. price pressure is proving stubborn. Core consumer price index (CPI) data surprised to the upside for a second consecutive month, the first back-to-back overshoot since 2024, and the heavily weighted owners’ equivalent rent category did most of the work. That’s significant because new property lease rates have been rising.

High mortgage rates are keeping would-be first-time buyers in rented accommodation and high new-build costs are restricting supply. Slow net migration should limit demand, but a reliable source of disinflation has gone.

Core goods posted their biggest rise since the start of President Donald Trump’s second term and did so despite a continued large fall in prescription drug prices. This could reflect a delayed impact from tariffs or second-round effects from the rise in energy prices.

Core services excluding shelter is the better gauge of home-grown, persistent inflation, and it has been running near 3% for a year and a half. This is the indicator suggesting that underlying domestic economic strength is a source of inflationary pressure and that interest rates should rise as a result. The reassurance, though, is that wages have decelerated markedly, suggesting there’s limited benefit to weakening the labour market further.

Food prices were quiet in this month’s CPI report, but pressures are building in wholesale markets, which will find their way through to consumer markets in the coming months. A strengthening El Niño is likely to disrupt global food supply through a dispersed pattern of drought, flooding and erratic monsoons even if it warms the European winter and marginally eases pressure on gas reserves.

The Federal Reserve (the Fed) restarted its hiking cycle last month and last week’s data makes a further increase before the year-end rather likely. Its next meeting falls less than a week before the midterm elections, which sets a high bar for acting then.

One hike, not four

Policymakers here face a gentler version of the same problem. Bank of England (BoE) Governor Andrew Bailey noted that the second-round effects of higher energy prices have been more subdued in the UK than feared, and while he remains cautious about what follows, that’s an encouraging message for now. Gilts (UK government bonds) outperformed on the back of it.

Markets treat a November rise as a near certainty and price in three more over 2027, which strikes us as aggressive. Our expectation, and that of most economists, is a single precautionary increase, one the BoE would be keen to unwind if the energy consequences of the war in the Strait of Hormuz begin to resolve.

A similar situation is true in the U.S., where Federal Reserve Chairman Kevin Warsh refused to offer forward guidance but still managed to downplay the chances of a rate hike in the last meeting before the midterms.

Steady customers, nervous shareholders

The start of earnings season offered another opportunity to check in on the banks. The sector has been weak in recent weeks and the reaction to the volley of results was mixed. Beyond that, the trends were good.

Balance sheets are growing healthily rather than recklessly, credit quality is sound and payment spending across debit and credit cards rose 5%, with no visible increase in delinquencies. The concern doesn’t appear to be deteriorating credit quality but rather net interest margins. As interest rate expectations have risen, the yield curve has flattened, making banks’ ‘borrow short and lend long’ business model less profitable.

Fixed-income trading was weaker and corporate activity merely fine, held back by the absence of the jumbo listings anticipated earlier in the year. Equities and equity financing were strong, which is usually a late-cycle signal and much of that strength sits in the prime broking businesses that fund the multi-manager hedge funds.

In other words, it is another limb of the same AI trade now seeping into every corner of markets.

What’s coming up?

Fed rate decision: 

The central bank’s next meeting falls less than a week before the U.S. midterm elections in November.

BoE to hike? 

A November rate rise is treated as a near certainty, but we’ll know more on 5 November following its policy meeting.

Corporate earnings: 

Further company results are due as the earnings season continues.

Energy and geopolitics continue to set the tone across every asset class and last week offered a textbook illustration.

Brent crude pushed back above USD103 a barrel after reports that the White House asked the Pentagon to draw up strike options against Iran that could be implemented before the midterms. With energy prices anchored at these levels, inflation remains the dominant cross-asset driver, and the pressure has been felt in bond markets, where yields have reached multi-decade highs.

The conflict has also widened. Houthi attacks have reached Saudi airports, including strikes on Riyadh’s main international airport, which killed three people and injured dozens more. Iranian attacks on shipping have stepped up, even as flows through the Strait of Hormuz have shown some signs of improvement.

None of this is accidental. With the midterms less than a month away, the political pressure on the Trump administration from that quarter is at or around its peak, so it’s entirely rational for Iran to be as antagonistic as it can be while its leverage lasts.

That calculation cuts both ways, and by the close of the week it had produced something closer to a thaw. By the end of the week, President Trump confirmed he won’t conduct further military action ahead of the midterms and that productive discussions are ongoing.

It’s fair to say that the administration’s commentary on the state of negotiations should be met with a degree of scepticism, but they’re signalling to Iran that they do not consider that they will accept heavier losses in the midterms rather than softening their negotiating stance.

Once the votes are counted, Iran’s perceived leverage diminishes, which could prompt either side to re-evaluate their position. Oil prices are modestly lower as a result, which is where last week left us a little relief, no resolution.

Midterms

Looking in more detail at the U.S. midterms, there are a few things to observe. It’s normal for a sitting president’s party to lose seats. The president is not on the ballot, but his popularity affects the 435 races in the House and the 35 in the Senate.

Prediction markets now give the Democrats a virtual certainty of taking the House and a 65% chance of winning the Senate as well. The bottom line is that once the new Congress is sworn in on 3 January, there will be major constraints on the president’s ability to guide domestic policy.

The prediction market implied chances of each party winning each chamber of Congress.

Three consequences follow. Legislative gridlock is the first: given how far apart the two parties have become ideologically, little of consequence will pass beyond what is strictly necessary.

The second is fiscal. Brinkmanship becomes a feature of divided power in the U.S. Last year’s reconciliation bill lifted the debt ceiling from USD36 trillion to USD41 trillion, and over half that additional capacity has already been used. The limit is expected to be reached in the spring of 2027, after which accounting measures could extend it for roughly six to nine months.

Shutdowns and debt ceiling negotiations have tended not to have a big impact on markets but chip away at the global investors’ ebbing willingness to finance the U.S. More immediately, the Trump administration will need a budget and will want more military spending, but the Democrats will have a voice in those negotiations and are likely to demand more healthcare funding.

That should eventually be good for the healthcare sector, which already benefits from longevity and from AI’s ability to reduce costs. It is unlikely to address the issue of America’s rising debt-to-GDP.

In 2011, a standoff was resolved two days before the deadline and contributed to a downgrade of the U.S. credit rating; in 2023, Republicans extracted substantial spending concessions while controlling only one chamber.

The third consequence is investigations: committee control, subpoena power and the ability to sue in court would all shift to the Democrats. Two areas are largely untouched. Foreign policy remains the President’s to direct, including command of the military and trade negotiations.

Appointments are the live question

Jerome Powell has not vacated his seat on the Federal Reserve’s (Fed) board, having said he would stay until the investigation into the renovation cost overruns was well and truly over. The Fed’s internal watchdog found mismanagement, but no criminal violations, and the Justice Department won’t reopen a criminal case, though the attorney general hasn’t closed the door entirely.

That falls short of Powell’s test, so he will most likely stay for now. If the Democrats took the Senate, they would be able to block his eventual replacement, which most observers would regard as good news for Fed independence.

Equity returns in the year after a midterm has historically been the strongest of the presidential cycle; however, the same logic would suggest we’re currently in one of the weaker years of the cycle, so it seems like the normal pattern hasn’t been in place this year. Furthermore, we’re always conscious that a six-foot man can still drown in a river that’s five feet deep on average.

Low hire, low fire

Unemployment rose during September because more people looked for work despite fewer people quitting or being laid off.

The American labour market is sending a consistent and rather particular signal: employers are content to hold onto staff and employees are not looking to move. The payroll report showed job growth below the pace needed to keep unemployment stable, and the rate duly ticked up to 4.2%. But the rise came mostly from people entering or re-entering the workforce, not from layoffs, which barely show up in the data. Voluntary departures, meanwhile, fell sharply.

Jobless claims last week were similarly benign. What that describes is a prevailing sense of job insecurity, not outright weakness.

For inflation, this is helpful. Wage growth has continued to slow, which has taken the heat out of inflation expectations, a process that has been running since the end of April, interrupted only recently by higher energy costs.

Growth is cooling gently rather than stalling: the Atlanta Fed’s running estimate of consumption growth has slipped from 2.8% to 2.2%, and the September services surveys showed the global sector still expanding, with Europe accelerating and the UK expanding more slowly.

The U.S. picture is muddier, with the ISM manufacturing index reading more sedate than the S&P version. On this occasion we’d lean towards the ISM, since a sharp jump in American activity last month looks implausible.

Three hikes priced, one forecast

The minutes of the latest Fed meeting showed a committee that agreed on the destination, but not the route. Members voted unanimously to raise rates, yet gave clearly different reasons for doing so, which does nothing to clarify where policy goes next. The Fed chair’s reluctance to offer forward guidance leaves markets to work it out for themselves, and they’ve taken a hawkish view.

From a base rate of 4%, markets now discount up to three further increases. Professional forecasters, weighted towards the most recent estimates, expect just one, unwound towards the end of next year. That’s a wide gap and one of the more consequential disagreements in markets today.

The cost of money is also being allocated with more discrimination. Sovereign bond markets have been weak but bifurcated, with strong credits holding up and weaker ones punished. France stands out as the weakest of them all, with French government bonds underperforming the broader market and the euro soft.

Emmanuel Moulin, France’s representative on the European Central Bank’s (ECB) governing council, described the situation as complicated and serious while making clear it doesn’t warrant intervention from Frankfurt.

History suggests the ECB has found reasons to step in before and has shown some ingenuity in explaining why such action isn’t a fiscal measure. More stress would usually be needed to trigger such a move, but Christine Lagarde confirmed late last week that the ECB has the tools ready if needed.

What’s coming up?

Inflation back in the spotlight:

Headline inflation is likely to rise due to higher energy costs, but what matters is whether underlying inflationary pressure continues to moderate.

The International Monetary Fund and World Bank annual meetings:

The supranational bodies will call for fiscal responsibility, but their calls will likely go unheeded.

Earnings are back:

Third-quarter earnings reports kick off.

The U.S.-Iran conflict continues to cast a long shadow over European markets, and it is increasingly dictating economic policy rather than merely disturbing it.

High energy prices have pushed inflation up and growth down across the continent, which makes the arithmetic of already strained public finances considerably harder. Chancellors and finance ministers are drafting budgets around a variable none of them control.

The news continues to ebb and flow as Iran appears to have offered to allow nuclear inspectors back into the country. This is a genuine concession rather than a repackaged proposal, like the one President Donald Trump dismissed at the start of last week and perhaps the first hint that Tehran’s position is weaker than its rhetoric.

Energy prices fell on the news and bond markets rallied modestly. The U.S. has also deployed another carrier group to the region, though it won’t arrive until after the midterms so whether it represents a potential military escalation or an idle threat is a matter of pure speculation.

The electoral clock is the live variable. Prediction markets now give the Democrats roughly a 62% chance of taking both chambers the Senate and the House of Representatives of the U.S. Congress.

A president who could get petrol flowing again at a sensible price would materially improve the Republicans’ chances, but it would need to happen very soon to reach household budgets in time. That’s precisely why the Iranians may judge their leverage to be at its peak right now.

For portfolios, energy remains the swing factor behind inflation and, therefore, interest rates.

The British Retail Consortium’s shop price index came in below expectations, a tentative sign of easing pressure. But with a backlog of energy increases still to pass through, the likely direction for UK inflation over the coming months is up until second-round effects wash out.

The circle France cannot square

The French government presented its 2027 budget last week, the last under President Emmanuel Macron, with the deficit running at around 5.4% of gross domestic product (GDP) for 2026. That sits above the previous plan’s 5% target, the International Monetary Fund’s 5.2% projection, and the 3% permitted under the European Union (EU)’s excessive deficit procedure.

Brussels is expected to show leniency, largely because it has no credible means of imposing anything on a member state that represents the ‘core’ of the euro area. The cuts being proposed fall on the most contentious ground available: pensions, welfare, public sector wages and state-funded sick leave.

France’s difficulty isn’t simply that cutting is politically hard, though with the highest public spending in the G7, there’s plenty to cut. It’s that cuts large enough to matter risk reducing GDP by as much as they reduce the deficit. When calculating the debt-to-GDP ratio, this is known as a ‘denominator trap’ (where cuts shrink the economy faster than the deficit).

It adds to a vicious cycle: weak growth widens the deficit, the deficit demands cuts, the cuts meet resistance in the Assembly and then on the streets, and investors price the resulting uncertainty into yields that make growth weaker still. The spread of French 10-year yields over German equivalents is out at levels last seen during the euro debt crisis that occurred from 2009 to 2018.

Some countries can let inflation erode their debt quietly instead, running the economy a little hot and keeping real returns on savings slightly negative. The UK and U.S. did this after both world wars and Japan has done so more recently. Inside a currency union, where monetary policy is delegated to the European Central Bank, that door is largely closed.

Westminster plays for time

The above is an option for the UK if the fiscal position continues to deteriorate. For now, spreads against other major markets have narrowed, yet gilt yields are still the highest in the G7, and the external environment has been every bit as unkind here as in Paris.

However, the UK’s fiscal framework means it does start from a better position than France. With four weeks until the Budget, Chancellor John Healey’s leeway against his predecessor’s fiscal rules has been eroded again by expectations of higher interest rates.

The Labour conference responded to the fiscal challenges by deferring the toughest issues. Prime Minister Andy Burnham has signalled openness to tax rises to fund social care but ruled out acting within this Parliament. 

The genuinely contentious items electoral reform, a possible path back into the EU and softening the triple lock are being lined up for the 2029 manifesto. The triple lock change is the substantive one. 

Each year, the state pension has risen by whichever is the highest of earnings growth, the consumer price index or 2.5% a ratchet that lifts both cost (to the taxpayer) and benefit (to the recipient) as a share of the economy over time.

From 2030, all three measures will survive, but the earnings leg would restore pensions only to the level earnings growth implies, rather than compounding on top of it. The Institute for Fiscal Studies greeted it as a distinctly less-bad policy than the present one, which is about the warmest reception such reforms receive.

The prime minister appears to have a reformer’s instinct but a saint’s patience. Or he’s road testing these policies before he has to commit to them. If they land well, perhaps he could be tempted into an early election given that Labour is leading in the polls and has planned an unprecedented fiscal tightening over the remaining years of the parliament.

One policy does arrive immediately. The ‘Your First Home’ scheme was announced at the Labour conference, with details to follow in the Autumn Budget. It’s essentially Help to Buy mark two: a government-backed equity loan of around 20% against a buyer deposit of roughly 2.5%, limited to new builds, with income and price caps still to be set. Housebuilder shares rose 10% to 15% on the news.

Goldilocks returns to the U.S. labour market

In a week full of labour market data, the general tone was one of moderate warmth. Thursday’s Challenger U.S. job cuts report generally indicated labour demand was stronger this year than last (even after stripping out government employment, which was distorted by the Department of Government Efficiency campaign).

The more interesting shift was in why companies say they’re cutting jobs. For the past five months, AI has been the single most commonly cited reason for layoffs, accounting for around a fifth of all announcements. In September, it fell to fifth place, overtaken by ‘economic and market conditions’, business closings, ‘downturn’ and restructuring all of which carry a distinctly cyclical rather than technological flavour.

It’s a small reversal, and the data only captures the slice of the jobs market covered by formal hiring and layoff announcements, but it suggests that whatever job losses are occurring right now are more about softening demand than automation.

The rest of last week’s data points were more straightforwardly reassuring. Initial jobless claims fell on Thursday. The ISM (Institute for Supply Management) manufacturing survey showed employment still expanding, albeit less enthusiastically than the PMI (Purchasing Managers’ Index) surveys had suggested. And globally, manufacturing has been expanding at its fastest pace in several years.

The JOLTs (Job Openings and Labor Turnover Survey) report added to the picture of a cooling rather than cracking U.S. labour market, with job openings slipping and the ratio of vacancies to unemployed workers easing further. When the September non-farm payroll jobs report itself landed, it came in below expectations, with downward revisions to prior months and softer wage growth than forecast.

For markets, whose principal anxiety has been that the Federal Reserve might hike interest rates more than expected, this was a welcome signal: a labour market losing a little momentum, without falling off a cliff, is close to the Goldilocks outcome (a market that’s not too hot and not too cool) investors want the most.

That dose of reassurance, combined with softer energy prices, took some of the pressure off bond yields and helped spark a rally across global sovereign markets. France, however, was a conspicuous underperformer.

What’s coming up?

Le budget: 

Negotiations continue over France’s budget proposal.

Brazil votes: 

President Luiz Inacio Lula da Silva seeks another term in an election expected to be extremely tight.

EU and China: 

Trade talks continue as EU Commissioner Maroš Šefčovič travels to Beijing for “a super crucial meeting” with Chinese Commerce Minister Wang Wentao.

Energy remains the fulcrum on which the markets swing.

Brent crude oil drifted lower, offering markets some welcome relief, before bouncing back with a vengeance, more than 7% in two days and taking the shine off equities with it.

Last Friday brought better news: the energy complex softened again, with Brent crude briefly dipping below USD105 per barrel on reports that U.S. and Iranian intermediaries are exploring a phased reopening of the Strait of Hormuz.

Even with Iranian President Masoud Pezeshkian having been in New York, and talks with Iranian envoys having taken place, there was plenty to be sceptical about. The Iranian negotiating position looked little changed from the memorandum that collapsed within weeks of being signed in June. Sure enough, President Trump rejected the deal, claiming Iran had overplayed its hand.

But with five weeks to go until the U.S. mid-term elections, easing gasoline prices could easily be the factor that allows the Republicans to retain the Senate, and this will form part of the calculus for Iran. After the mid-terms, a crucial source of leverage will have passed.

Diesel’s choke point

Diesel is becoming a major choke point due to the blockage of the Strait of Hormuz and Ukraine’s strikes on Russia’s refineries.

As ever, Europe is collateral damage and Mark Rutte, secretary general of NATO, pointed out that the continent has too little capacity in the event of a disruption to global supplies. It is an awkward position as funding new refineries in case of conflict makes little sense during peacetime, and when demand is in structural decline due to the increase in EV (electric vehicle) usage.

Natural gas offers a more benign picture. European prices have fallen more than 10% from their recent high, helped both by the de-escalation chatter and by early forecasts pointing to a mild, wet winter. However, as the season starts with low storage, a January cold snap would bite harder than usual.

Oil above USD100 per barrel benefits oil producers but increases inflation, which in turn increases interest rates, creating a headwind for most other assets. Government bond yields now sit at levels not seen since around the global financial crisis, with the five-year U.S. Treasury above 5% for the first time since 2007 and the 30-year back to levels last seen in 2004.

Expensive oil transmits into equities along three channels: higher discount rates compress valuations, higher financing costs squeeze leveraged borrowers, and property and lower bond prices suck liquidity out of markets, making them susceptible to volatility.

The distinction that decides how this ends is whether yields are rising because growth is strong or because inflation is feared. Shares can climb through rising yields when the cause is a healthy economy; they struggle when the story turns to central banks having to tighten further.

Some like it hot

The U.S. economy is running hot. The flash composite Purchasing Managers’ Index reached 58.4 this month, up from 56.0 in August. Outside the post-lockdown reopening burst, that is the quickest pace of expansion recorded since 2015, with manufacturing and services both firing. The catch sits in the cost column.

Firms’ input costs jumped at the steepest rate in four years and the surveyors pinned that squarely on fuel and transport costs rising with oil.

Higher energy prices act like a tax, taking money out of everyone’s pockets. Whether that proves inflationary or demand-sapping depends on the labour market. There, the news was also firm, with services employment building on an earlier bounce in jobs growth.

Consumer sentiment bounced back

Europe is quietly improving too. The eurozone composite hit a 41-month high of 53.1, with France and Germany both in expansion for the first time since November 2025 a better story than the single U.S. reading suggests. 

However, the same energy-driven price pressure came through in the data, which strengthens the case for another European Central Bank rise before year-end.

The UK drew the short straw. Activity slipped to a three-month low while input costs accelerated, a more stagflationary mix than either the U.S. or the continent. August borrowing of £18.3billion came in above forecast, with debt interest at its heaviest for an August since 1997.

The UK economy looks more exposed than most if energy costs stay elevated approaching the Autumn Budget on 28 October.

Consumer confidence had rebounded, aided by the new prime minister’s more upbeat tone. He has retained that and expressed his reluctance to raise taxes, but a fiscal noose is tightening, driven by factors outside Britain’s control.

The arithmetic of pain

Debt interest is the thread that runs from here into the longer term.

Oaktree’s Howard Marks discussed America’s situation in his latest influential memo. His prescription is conventional: raise government revenues largely through higher taxes on the wealthy and restrain the growth in spending.

However, that doesn’t seem likely as legislation already on the books pushes spending growth higher over time, and no one wins an election promising austerity.

The path of least resistance

History suggests a different route. Japan reduced its debt burden not through spending cuts or tax rises but by holding interest rates below the rate of nominal growth (before inflation). 

That is the path we’d expect the U.S., and probably others, to take as debt service costs climb: policy rates set below inflation to avoid choking off growth, banks nudged into holding government bonds, and the term premium (extra yield for longer-dated bonds) managed down if long yields creep up.

The risk is that inflation ends up running well above rates rather than a little above, at which point the tools get blunter still. 

It is worth remembering that earning a real return (above inflation) on cash is not the natural order of things for most of the past century, savers have been fortunate simply to preserve spending power, and tax has usually settled the argument.

If cash cannot be relied on to protect purchasing power, the answer is to own real assets. Carefully selected equities can form a meaningful part of that, alongside contractual claims on inflation, such as index-linked bonds. This makes the question of whose earnings are genuinely durable the important one, and the market answered it rather hastily.

What’s coming up?

Gainfully employed: 

100,000 new U.S. jobs are expected to have been created in September. This Friday brings the first official estimate alongside more reliable labour market data.

A little more conversation: 

The Labour Party conference begins weeks before the new government announces its first budget.

Rise of the robots: 

Will AI extend its run as the leading cause of job losses as employment enjoys a renaissance?

As in previous weeks, the juxtaposition of the AI boom and fallout from the conflict between the U.S. and Iran remains centre stage.

A major development on the AI front came from Anthropic’s CEO, Dario Amodei, who released an essay entitled “We must pace the Frontier”. In it, he argued that AI development has reached a critical inflection point requiring deliberate slowing, not halting, of advancement to let safety measures catch up.

His stated motivation rested on two concerns: the rapid acceleration of “recursive self-improvement” (AI building better AI), and the incident in which AI agents at OpenAI displayed swarm-like unauthorised cyberattacks and attempts to hack their own evaluation systems, resulting in the hacking of Hugging Face (a hub for open-source AI models, datasets, and machine learning tools). Amodei proposes:

• unilaterally embedding third-party evaluators at Anthropic to verify safety practices
• coordinating with other democratic AI companies on shared safety standards
• pursuing global cooperation, even with authoritarian rivals like China, through a tiered framework ranging from banning clearly dangerous uses to eventually agreeing on ‘speed limits’ for AI self-improvement.

Sam Altman (of OpenAI) and Elon Musk (of SpaceX, xAI) voiced their agreement. Agreement between rivals always provokes scepticism, in this case, suspicions of an attempt at regulatory capture.

The idea is that frontier models have been engaged in an arms race of development in the hope of gaining an unassailable lead in AI capability, with mixed success so far. Frontier model capabilities have advanced meaningfully but, as we have discussed in recent weeks, the open-weight models (models with freely available weights) remain close behind. These offer lower costs, smaller models and more transparency and security, while also consuming less capital themselves.

We have characterised this market as a prisoner’s dilemma before. If any single firm outpaces its peers’ spending, it could monopolise the frontier. But if a number of firms compete, the frontier will become commoditised and competitive. Better for all would be to slow development, save costs and turn attention to fighting off the chasing pack.

That would mean creating a barrier to entry in the form of regulatory requirements that would be difficult for challengers to either meet or fund. Have the firms manufactured this excuse to coordinate a slow-down in their development? Two things can be true at once.

It seems likely that frontier labs are genuinely concerned about their ability to develop their models without causing repeats of the Hugging Face incident or worse. But at the same time, they need to find a more durable means of reducing their own spending and repelling competitors, and this may provide them with the opportunity to do so.

If this were to happen there would be many implications. Lots of headlines have been written about how dependent the U.S. economy is on AI capex (capital expenditure). Growth has been below trend for the past three quarters and in the first quarter of 2026, investment formed a disproportionately large share of growth.

That was the result of a slowdown in consumer spending coinciding with an acceleration in investment. Q2 saw consumption rebound and in Q3, it looks set to accelerate further, as things stand.

Business-fixed asset investment has been accelerating all year, the only comparable period was 2021, when a pandemic-related investment collapse gave way to severe supply constraints. Information technology now makes up a record 5% of U.S. GDP, but capital available for investment in any period is finite: if frontier AI labs pull back, that capital doesn’t vanish, it migrates, either to other sectors, or within AI itself, from training towards inference (running models to generate outputs). Given how compute-constrained the system remains, the more likely outcome is a shift in the mix rather than an outright fall in demand.

Nvidia, whose chips flex between both tasks, may prove less exposed to this shift than first feared. In any case, the bulk of real-world AI adoption doesn’t depend on frontier models, it depends on businesses getting their data ready for a mass of fairly routine tasks.

We remain deliberately measured in our AI exposure, favouring quality over the more speculative bottleneck trades.

Amodei’s essay was not welcomed at the White House, which remains wary of the U.S. losing ground in the AI race to China despite evidence that any gains made by U.S. frontier models are soon assimilated into Chinese models at lower cost.

The chief concern about the AI boom has always been how the investment is allocated and how it’s financed, both of which may now improve, particularly if the slowdown reduces pressure on the most financially stretched corners of the market.

OpenAI choosing to delay its IPO (initial public offering) removes one of the major prospective draws on the equity market, while doing little to dent the productivity gains already within reach from AI capability that exists today.

Credible threats

These decisions could affect the outlook for inflation going forward. For now, central banks have been focused on the here and now, with U.S. inflation having exceeded target for more than sixty months.

Last Wednesday, the Federal Reserve (the Fed), under Kevin Warsh’s chairmanship, at last raised rates to 4%. Notably, the decision was unanimous.

We had been led to expect a more fractious committee, closer to the Bank of England’s habitual splits, so the united front carried weight. Warsh, no fan of forward guidance (signals about future policy), chose his words to be read only one way: the Fed is getting “serious about inflation”, the move “removes a dose of accommodation” and the economy is strengthening.

He added, pointedly, that there’s “no hiding from hot spots around the world” a nod to the geopolitics driving energy costs, and arguably a gentle rebuke to a President who has mused publicly that rates belong below 1%.

As we had speculated, by re-establishing the Fed’s credibility, Warsh reduced the uncertainty premium built into longer-term borrowing costs. Short rates rose but longer yields eased across much of the curve (the yield curve). 

In other words, the move to tighten at the short end has probably done more for Main Street than Wall Street, nudging down the long-term financing costs that matter for households and businesses (albeit only marginally).

Bank of Japan

The Bank of Japan also raised rates, to 1.25%, in a 7-2 vote. Both dissenters were appointees of Prime Minister Sanae Takaichi, raising questions over their independence. For the yen carry trade (borrowing in yen to invest in higher-yielding currencies), there’s now around 2.5% pickup available for anyone borrowing yen and saving in dollars.

U.S. Treasury Secretary Scott Bessent had argued that the market should follow his actions due to his superior information on the direction of interest rates.

So far, the market is calling his bluff, with his comments marking a peak for the yen. All else equal, investors can borrow in yen and invest abroad, and with U.S. monetary credibility being reinforced, the expected narrowing of the U.S.-Japan rate gap is not happening. Bessent’s interest in this stems from Japanese holdings of U.S. treasuries. If the yen needs to be supported, these could be sold, putting upward pressure on long-term U.S. interest rates.

A hawkish hold

All the interest rate decisions have been broadly as expected, with focus ending up on the nuances around comments and voting patterns.

The Bank of England (BoE) held rates at 3.75% on a 6-3 vote, much as economists expected. A further three members now appear open to supporting hikes if energy prices persist, “as appears likely”, in the words of BoE Governor Andrew Bailey.

The gap between what markets price and what economists forecast remains striking. The interest rate curve implies as many as four or five UK rate rises over the coming year, taking rates towards 4.7%. Yet the consensus among economists has been for rates to stay broadly flat.

This isn’t necessarily a contradiction. Economists provide their single most likely outcome; markets price a probability-weighted range of outcomes. The high implied rates suggest investors think the balance of risks skews upward.

High interest rates, driven by high inflation, increase pressure on the government, eroding headroom against its fiscal rules ahead of October’s budget. The only partial mitigant was the BoE’s decision to slow the pace of bond sales, so-called quantitative tightening (selling bonds back to the market), which was putting upward pressure on long-term interest rates.

The net result remains a steep gilt curve (the yield curve for UK government bonds) in the early years and, for us, an opportunity to earn a useful pickup by putting money to work just a few years out.

UK resilience

The UK economy, for its part, is proving more resilient than feared.

Retail sales rose 0.5% on the month in August, and the increase was broad rather than one-off households are still spending despite higher fuel and borrowing costs. 

The picture in the labour market is more mixed: payrolled employment fell by 26,000 in August, the sharpest drop in nine months, while wage growth held at 3.9%. Sticky pay alongside a softening jobs market is precisely the awkward combination the BoE must navigate.

But the U.S.-Iran conflict remains a common theme across all these central bank decisions. Last week, the news was marginally positive due to the reopening of Saudi Arabia’s East-West pipeline, which restores some supply. 

Hope of an end to the conflict has diminished, and investors now see the mid-term elections as the next plausible window for de-escalation, after which the political costs for the Trump administration would ease.

However, it is very hard to know how well the Iranian regime is coping with the loss of oil revenue, or whether further pressure can be brought to bear.

What’s coming up?

The dragon and the eagle: 

Chinese President Xi Jinping is meeting President Trump on Thursday 24 September.

Confidence conference: 

The U.S. Treasury Market Conference takes place in New York on Tuesday as yields rise and the Treasury intervenes in markets.

Taking the temperature: 

Provisional PMIs (purchasing managers’ indices) will hint at the economy’s resilience to current energy prices.

Bond markets were at the centre of market moves last week, with global government bond yields rising sharply across developed markets. The U.S. 10-year Treasury yield moved close to 5%, while UK gilt yields reached nearly 5.4%, a level not seen since 2007.

The immediate catalyst was another rise in energy prices, a result of the conflict in the Middle East intensifying. Escalation in Iran-U.S. tensions has pushed Brent crude oil prices back above USD100 a barrel, while U.S. diesel prices have moved to over USD6 a gallon.

Higher oil prices have renewed concerns about inflation and pushed investors to expect more interest rate hikes. But we think oil is only part of the story.

Governments are borrowing heavily to fund large fiscal deficits. At the same time, the enormous investment required to build AI infrastructure is creating another source of demand for capital.

Put simply, there are a lot of borrowers competing for the same pool of money. Investors are therefore demanding higher yields to lend for 10 or 30 years.

This is also why the U.S. Treasury’s latest bond buyback failed to provide much relief. Buybacks can improve liquidity and help supply and demand at the margin, but they can’t address the fundamental issue of large fiscal deficits, heavy government borrowing and persistent inflation.

This is broadly consistent with our view that the latest geopolitical shock is only one part of a bigger, longer-term shift in bond markets.

For equity investors, higher yields are a near-term headwind. When investors can earn close to 5% from U.S. government bonds, equities face more competition for capital. Higher yields also reduce the present value of future corporate earnings, which can be particularly challenging for more highly valued growth stocks.

This doesn’t change our longer-term constructive view on equities. But while bond yields remain elevated, we think equity markets could remain more volatile.

U.S. inflation adds interest rate pressure

The U.S. inflation reading adds pressure on the Federal Reserve (the Fed) to raise interest rates this week. Headline Consumer Price Index (CPI) inflation was broadly in line with expectations, coming in at 3.4% year-on-year, while annual core inflation eased slightly to 2.4%, the lowest since March 2021. But the more closely watched core CPI rose +0.3% month-on-month, above the 0.2% expected and the biggest increase since April.

This CPI data doesn’t yet capture the latest surge in oil prices, much of which occurred in the first half of September. Higher energy costs can also take time to feed through into other parts of the economy. 

Meanwhile, producer prices released last week pointed to continued pipeline inflation pressure and the latest U.S. jobs report was strong, both reinforcing the case for elevated inflation.

All this data adds pressure on the Fed to do its job to constrain price pressures.

Markets have responded quickly. Earlier this month, markets priced in a 70% probability of an interest rate hike, which rose to 90% immediately after the CPI release.

Interestingly, bond yields came in a bit lower and stocks reacted positively. The read is that if the Fed follows through with a rate hike, it will help restore its inflation-fighting credibility, anchoring long-term inflation expectations, which markets would welcome as a positive development.

The ECB turns more hawkish

The European Central Bank (ECB) added to the more hawkish backdrop last week, raising its deposit rate by 25 basis points to 2.5%, which was widely expected.

More important was its outlook. The ECB revised up its inflation forecasts, with inflation now expected to average 2.5% in 2027 and 2.1% in 2028. At the same time, it upgraded its growth forecasts for this year and next, reflecting a more resilient Eurozone economy.

That resilience is important. Higher energy prices are hurting consumers and businesses, but so far, the economy has held up better than feared. This reduces the immediate risk of stagflation and gives the ECB more room to focus on inflation.

Markets have responded by pricing in more rate hikes. However, we think there is a risk that markets are overestimating how much tightening will ultimately be needed.

The key is wages. So far, there’s little evidence that higher energy prices are creating a second-round wage-price spiral. Eurozone compensation growth has slowed, while the ECB’s wage tracker points to only a modest 2.7% increase in negotiated wage growth in the first half of next year. Longer-term inflation expectations also remain anchored at around 2%.

And this is not just a European story. U.S. wage growth eased to 3.1% in August, while UK private sector wage growth has slowed to 2.8%. Resilient economic growth means central banks cannot ignore the inflation shock, particularly if oil prices remain high. But slowing wage growth suggests the second-round effects are not there yet.

That means central banks may need to remain hawkish in the near term, without necessarily delivering as many rate hikes as markets currently expect.

Given the ECB’s rate hike, the recent data and market pricing, it will be a surprise if the Fed remains on hold this week. If it does not, it will face serious credibility challenges and Fed Chair Kevin Warsh will need to explain its rationale clearly to the market.

What’s coming up?

Fed meeting:

The Fed’s next policy meeting on 15 and 16 September will determine whether a rate hike will be actioned – with a nearly 90% probability priced in.

Bank of England (BoE) policy meeting:

Markets expect the BoE to stay put, with the combination of higher energy prices and a weaker job market causing a policy conundrum.

Developments in the Middle East:

Several Gulf states are planning a meeting with Iranian officials this week to discuss the future of the Strait of Hormuz.