00:00It's an arm wrestle, isn't it? Unfortunately, I think both sides now are waiting to see whether the economic pain
00:06that this is inflicting will force the other to concede.
00:09In the meantime, markets are more focused on earnings, in my opinion, and there the news has been good.
00:14Obviously, the consumer sectors are seeing some pressure, but the upgrades that we're seeing from tech and from energy are
00:21more than offsetting that consumer downside.
00:23And therefore, it feels to me like markets are increasingly trying to look through what's coming out of the Middle
00:29East.
00:29I think it's difficult, particularly when the headlines move so quickly from positive to negative.
00:34It feels like, if at all possible, equity investors are trying to refocus back on fundamentals.
00:41But what we have to bear in mind is that the Q1 results are really not going to capture the
00:46full economic impact of this fallout in Iran.
00:48Well, indeed, and we're looking at the PMI numbers this morning, much weaker than expected in the euro area, the
00:54composite meeting pointing to a contraction in private sector activity.
00:57Now, the UK numbers were actually very strong, all performing better than had been expected, and services and manufacturing both
01:03growing.
01:05Are we setting essentially markets up for a fall with the economic prospects souring as they are?
01:11I mean, I certainly wouldn't be reading into the UK positivity this morning and translating that into a durable trend.
01:17I think the move that we're seeing in input prices across the European PMIs today is really the key indicator.
01:24And that is telling you that business costs are rising sharply and that they haven't yet passed that fully on
01:30to consumers, but their intentions to do so are also rising.
01:34So this is some of the timeliest data we've had since the start of this conflict.
01:38And, OK, you know, services in the UK is holding up a little bit better than expected.
01:44But to me, we know that this shock is going to put upward pressure on inflation.
01:48It's going to put downward pressure on growth.
01:50And the size of that is going to be dictated by how long we're left with with no supply coming
01:55out of the straight.
01:57Does that deal a blow that that I mean, when does this start to look like a 2022 inflation shock?
02:05I mean, how long does the straight need to be closed before we're into that sort of territory?
02:09Or is that simply not going to happen this time around?
02:11This is not 2022.
02:13In my view, I think the starting point for the economy when this shock hits looks so different to where
02:18we stood back in February four years ago.
02:21You think about where inflation was at the time in the UK, we were at five and a half percent
02:26and rising this time round.
02:28We were much closer to three percent.
02:29You look at where interest rates were for the UK at that time when Russia invaded Ukraine, UK interest rates
02:36were at 0.5 percent.
02:38Ten year yields started with a one.
02:40The economic backdrop was so different.
02:43Today, you look at labor markets that are significantly softer.
02:46You look at the material progress that we've made on inflation.
02:49So clearly, inflation is going higher over the next few months.
02:53But I personally don't think that 2022 is a fair comparison, just given how much more vulnerable, frankly, the growth
03:00backdrop is today versus all of that pent up demand that was hitting the economy in 2022 and the revenge
03:06spending that we were talking about at the time after two years of consumers being locked up and parking savings
03:12away.
03:13Okay. So we're far away from that situation.
03:16I wonder, though, when thinking about the movements that we've seen in the dollar, you know, it has strengthened during
03:23the conflict as well.
03:24Although, again, a bit of a pause since we've had the ceasefire.
03:28Where do you see the dollar trajectory going from here?
03:30Is this a reversal of last year's trend?
03:33In my view, no.
03:34I think there is further downside for the dollar ahead.
03:37And to me, the moves in March told you much more about popular positioning going into this shock having to
03:43be scaled back rather than any change in the underlying fundamentals.
03:47You look at all of the biggest movers over the first few weeks of this conflict.
03:51It was gold down.
03:52It was the dollar up.
03:53Japanese and Korean equities down.
03:56It was UK gilts being hit the hardest.
03:58Those are all some of the most popular consensus trades with investors positioning for further upside in gold, further upside
04:05in the AI trade in Asia, and expectations of fairly rapid Bank of England rate cut.
04:11So I would not view the stronger dollar performance that we've had since the start of this war as a
04:17sign that international investors really are returning to the greenback as a source of a safe haven trade.
04:23I think fundamentals point to a weaker dollar.
04:26That's a less exceptional U.S. growth backdrop versus the rest of the world.
04:30That's more fiscal stimulus coming in places like Europe and Japan as interest rate differentials no longer as supportive as
04:37well.
04:37All of those factors, I think, support a reallocation of capital around the world, which is likely to weigh on
04:43the U.S. dollar ahead.
04:45Okay, and in terms of the AI trade, I mean, it's been one of the constant points of strength during
04:51this whole crisis.
04:52I was just looking at the STMicro results this morning.
04:53Again, very positive forecast, and we heard similar things from some of the other European players in this story as
04:59well.
05:00Are there any doubts there?
05:01Do you, you know, are you kind of as, do you, it doesn't look as positive as it did before
05:07is what I'm trying to get the words out of my mouth to say.
05:09I know what you mean. I guess the question we're asking as a result of this conflict is to what
05:14extent the CapEx commitments from the AI names are going up because of new capacity being added,
05:20or the extent to which this is simply because the cost of building, the cost of buying semiconductors and producing
05:26semiconductors is going up.
05:28And therefore, you effectively have cost inflation driving those CapEx numbers higher.
05:33And I think the market reaction to some of the early results that we've seen has actually been pretty telling
05:37in that depending on where you are within the AI ecosystem,
05:41you're getting very different results.
05:43If you're early on in that supply chain, if you're the memory providers, you're doing very well.
05:49NVIDIA alone is expected to deliver close to 40% of U.S. earnings growth for this quarter as one
05:55company.
05:55But if you're further down the pipes, if you're looking at being the purchaser of that equipment, you're being hit
06:02harder.
06:03You look at the Tesla reaction last night and the way in which a positive earnings release was initially met
06:08by a strong market reaction,
06:09only for the market then to start to pull back off the back of those increased CapEx commitments.
06:15So investors here are looking for two things.
06:17They're looking for, one, companies that are in the right place along that AI supply chain.
06:23And then two, for the hyperscalers, they're looking for strong earnings, but combined with CapEx discipline.
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