Midterm Relief Rally

MACRO FRAME

Investors are rotating out of tech as a Q3 earnings reflect sharp drops in free cash flow. Recent price action suggests a repricing of the AI trade rather than a deterioration in macroeconomic sentiment.

STOCK INDEX FUTURES

Equity index futures were higher overnight as a post midterm relief rally sweeps across markets. The Democratic sweep of Congress leaves Congress divided from the White House. Despite stellar earnings from AMD, the Nasdaq is lacking the Dow and S&P as a Democrat-controlled congress seems more likely to scrutinize data-center electricity demand, AI safety and local infrastructure, potential risks to the broader space. A divided government makes large changes to taxes, spending and federal regulation harder to enact. Democratic congressional majorities do not, by themselves, eliminate the obstacle of President Trump’s veto. Deeper partisanship could complicate spending and debt-ceiling negotiations. Prolonged shutdowns or fiscal standoffs could unsettle bond investors, lift Treasury yields and pressure equity valuations. On the corporate side, AMD rose approximately 7.3% in premarket trading after forecasting more than 80% revenue growth in 2027, above the 77% analyst. Third-quarter data-center revenue increased 97% to $8.55 billion, exceeding expectations of $8.20 billion. The results reinforced evidence that AI infrastructure demand remains robust and extends beyond Nvidia’s accelerators. ISM services PMI later in the morning will give further indicators on the pace of economic growth and price pressures in the economy.

CURRENCIES

US DOLLAR: The USD index gapped lower overnight and is down 0.51% to 101.348. Concerns that greater scrutiny of AI infrastructure could constrain a key growth driver contributed to the softer tone, alongside lower Treasury yields. Whether the decline persists will depend on incoming economic data and evidence of changes in investment spending. A further drop in oil prices is pressuring the dollar, though Gulf uncertainty remains a countervailing risk. Today’s ISM services data will be a key catalyst in furthering dollar direction, with a strong prices index likely to shore up bets of a December hike, October’s nonfarm payrolls data (63k est.) will help shape the narrative around Fed policy, though ultimately inflation data offers the best guidance on how the Fed will act on rates. December rate hike odds are priced at 80%.

EURO: The euro is 0.57% higher at $1.1256, primarily reflecting broad dollar weakness following the election. Eurozone inflation rose to 4.0% in October, up from 3.8% in September, its highest level since September 2023. Energy prices continued to contribute a large share of the headline increase, with energy inflation up 20.8% y/y, its highest level since December 2022. Services inflation also rose to 3.3% y/y from 3.2%, while, core inflation remained unchanged at 2.5%, in line with expectations. Inflation rose in France to 3.8% from 3.4%, Italy to 5.6% from 4.2%, and the Netherlands to 3.3% from 3.0%. In contrast, Germany’s inflation rate eased to 2.8% from 3.3%, partly reflecting a temporary fuel tax cut, while Spain’s rate edged down to 4.9% from 5.0%. Money market expectations have risen modestly in response to the data, pricing a 70% chance of a hike in December from 66% before the release and see 56 bps of tightening over the next 12 months. The ECB’s hawkish hold and forward guidance has all but guaranteed a rate hike at the bank’s meeting in December. The euro’s upside, however, is likely to be contained by the prospect that December’s rate hike will be followed by a pause.

BRITISH POUND: Sterling is 0.56% higher at $1.3485, supported by dollar weakness and expectations of a Bank of England rate increase on Thursday. With a hike already anticipated, the accompanying guidance will be important. Any pushback against market expectations for three to four increases in 2027 could temper sterling’s advance, particularly if the decision is interpreted as a dovish hike. With the government’s recent budget announcement offering no surprises, price direction in the pound will be more reflective of BoE expectations and the Sterling’s relative strength over the euro. While the UK economy has shown resilience over recent months, the bank will likely remain cautious against future rate hikes to avoid slowing its fragile growth backdrop. Elsewhere, falling oil prices and hopes of a resolution to US-Iran hostilities will be supportive of the currency.

JAPANESE YEN: The yen fell 0.15% to 158.42 yen per dollar. Softer US Treasury yields and broad dollar weakness provided the backdrop, although the yen’s advance was smaller than those of the euro and sterling. Underlying inflation has hit levels consistent with the bank’s 2% price target, which should open the door to future rate hikes from the BOJ. Money markets are nearly fully-priced for a rate hike in January and see 67 bps of tightening over the next 12 months. With the bank now cautious about overshooting its inflation target, it could potentially speed up the rate of hike from roughly every six months to every three months, leaving the door open for a hike at the December meeting. The BOJ characterized financial conditions as accommodative, though the pace of future hikes ultimately depends on upcoming data.

AUSTRALIAN DOLLAR: The Aussie is up 0.73% to $0.7018. The Reserve Bank of Australia hiked rates 25 bps in a split 6-3 decision and removed language explicitly stating its willingness to raise rates further if necessary in its policy statement. Signaling an end to its hiking cycle. Market-implied odds of another increase before year-end have fallen to roughly 9% from 40% before the announcement.

TREASURY FUTURES

Yields fell across the curve Potential constraints on additional fiscal expansion and concerns about slower AI-related investment offered support, while lower oil prices provided some relief on the inflation front. The longer-term fiscal implications remain less straightforward. Divided government could restrain spending, but prolonged budget disputes could also increase uncertainty and the compensation investors demand to hold Treasuries. Political paralysis, rather than orderly fiscal restraint, however, could ultimately lift yields and pressure equity valuations. ISM services PMI data later in the morning will be the next catalyst for yield direction and for the monetary policy outlook. A combination of firmer activity without relief from cost pressures will continue to argue for higher rates over the coming months. Friday’s payrolls will be central to determining whether labor-market resilience continues to justify another increase. September’s PCE argues against the narrative that the Fed can remain on hold.  Warsh did imply a hesitancy to raising rates higher, saying “the goal isn’t to throw sand in the gears of the economy and throw people out of work,” implying the Fed does not want to raise rates enough to actually slow the economy. This may reflect a slower pace of future tightening than what the market has/had priced in. However, upcoming data will ultimately be the factor that shapes the trajectory of Fed policy. If growth and inflation continue to grow, while labor conditions remain steady the Fed will likely need to raise rates by 50 bps over the coming 12 months. However, if the data proves accommodative, the market could experience a curve-steepening, reflected by a drop in short-term rates. Near-term risks to the Fed raising rates are in the form of a divided government post-midterms that results in a debt-ceiling gridlock, while the geopolitical risk of renewed US-Iran strikes complicates the oil trajectory. These conditions would add to volatility in the market that may result in the Fed want to remain on hold to avoid adding further stress to the market.

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