LIVE MARKETS-The Blue Wave and the economy

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THE BLUE WAVE AND THE ECONOMY

The Democratic Party's decisive victory over Republicans in the US midterm elections led to volatility in US markets as investors saw the results slowing artificial intelligence development and bringing gridlock to Washington.

But Sonal Desai, portfolio manager and chief investment officer at Franklin Templeton Fixed Income, questioned the suggested impact of the results on the US economy.

First off, Desai took apart the argument that slower AI infrastructure investment would reduce growth enough to lead the Federal Reserve to a less hawkish stance.

The money manager isn't disputing that several states such as Texas and Ohio may adopt "a less-welcoming attitude to data centers."

She says that "data centers are less likely to benefit from fiscal incentives and more likely to have to contribute to building new power generation, or pay subsidies to help defray the higher cost of power due to their additional demand, and maybe commit to boosting local employment."

But while these challenges could increase build-out costs, they are "not insurmountable." And she sees the adverse impact on economic activity as moderate.

Desai says the AI capex contribution to GDP peaked at 1.4 percentage points out of an annual growth rate of 2.1% in the third quarter. But, looking under the hood, she suggests that if some things, such as imported hardware, are subtracted, it would "at least halve the contribution of AI capex to growth," bringing it to less than one-quarter of the US economy's growth rate.

"Clearly this is a meaningful contribution, but far from the only driver of US growth," the money manager notes.

Meanwhile, Desai describes the notion that a divided government would narrow the fiscal deficit as "wishful thinking."

Put simply, a "desire to spend more" is the one thing uniting Democrats and Republicans, according to the CIO.

Desai points to Democratic election campaigns featuring spending promises and Democratic leaders' post-election reiteration of aims "to reverse Medicaid cuts, extend Affordable Care Act tax credits, raise the federal minimum wage; reverse cuts to child care tax credits and Supplemental Nutrition Assistance Program and eliminate the State and Local Tax deduction cap."

And across the aisle, she says: "The Republicans for their part have shown little support for fiscal restraint, and if anything are likely to want to spend more in areas like defense."

So, she sees dealmaking between the parties creating "an even wider fiscal deficit."

In all, Desai argues that "the growth outlook remains healthy" and that looser fiscal policy and "potentially lower energy prices, if the Iran crisis is resolved, would be positive for economic activity and would outweigh the limited headwind from a potentially slower pace of AI infrastructure investment."

So, a "resilient economy, a strong labor market, and entrenched inflationary pressures," along with potential marginal reductions in price pressures from energy and Trump's tariffs, could put the Fed on track for "another two to three rate hikes, starting most likely in December."

(Sinéad Carew)

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