AI Booms, Fiscal Strains and the New Macro Regime ft. Joe Little

[00:00:09] Joe

“I’m cutting rates, boss.”

But the long bond is misbehaving. It keeps going higher. Greenspan and Bernanke called it the ‘bond yield conundrum’.

I’ve been calling it the ‘reverse conundrum’ today because everything seems to be the other way around.

So, I think the underlying dynamics, where we’re seeing steeper yield curves, rising term premium in bond markets, that all looks to me that it’s quite consistent with a concern around debt, a concern around fiscal dominance, a concern around fiscal inflation risks coming back to the fore in in a way that we just were safe to ignore all of that for the last 20 years prior to the kind of COVID pandemic.

[00:00:55] Intro

Imagine spending an hour with the world’s greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more. Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world so you can take your manager due diligence or investment career to the next level.

Before we begin today’s conversation, remember to keep two things in mind. All the discussion we’ll have about investment performance is about the past and past performance does not guarantee or even infer anything about future performance. Also, understand that there’s a significant risk of financial loss with all investment strategies and you need to request and understand the specific risks from the investment manager about their product before you make investment decisions. Here’s your host, veteran hedge fund manager Niels Kaastrup-Larsen.

[00:01:50] Niels

Welcome and welcome back to another conversation in our series of episodes that focuses on markets and investing from a global macro perspective. This is a series that I not only find incredibly interesting as well as intellectually challenging, but also very important given where we are in the global economy and the geopolitical cycle. We want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macro-driven world may look like. We want to explore their perspectives on a host of game changing issues and hopefully dig out nuances in their work through meaningful conversations. Please enjoy today’s episode hosted by Alan Dunne.

[00:02:35] Alan

Thanks for that introduction, Niels. Today I’m delighted to be joined by Joe Little. Joe is Global Chief Strategist at HSBC Asset Management. He leads the firm’s macro and multi asset research, sets the house view on global markets and long-term asset allocation, and is the author of HSBC’s flagship House Views. He’s been at the firm for a number of years and before that was an economist at JP Morgan and a global macro PM.

Joe how are you? Great to see you. Great to have you on TTU.

[00:03:05] Joe

Thanks a lot, Alan, great to see you. Thanks a lot for having me. I’m a longtime listener, first time caller to the show, so it’s great to be on.

[00:03:13] Alan

Great, delighted to have you on and looking forward to hearing everything you have to say about global markets and asset allocation and all you’re hearing from your investors as well. I know you speak to a lot of different clients, in Asia in particular and do a lot of travel, so very much we’ll look forward to hearing all of that.

We do like to start off by getting a sense of how people got into markets and economics in the first place. So, what got you involved back in the day?

[00:03:39] Joe

Yeah, some time ago now. I mean, I studied economics, Alan, so I guess that was where I sort of started thinking about macro trends, maybe becoming aware of financial markets. But I always thought I’d go into some sort of policy role being a SPAD or some sort of special advisor working at the bank of England or something like this. And it was a bit of a happy accident in the end.

I stumbled into a great role at JP Morgan in London working with some terrific people in the equity research, equity strategy team, macroeconomic team. And I love that combination of macro and thinking about investment markets.

So, I had this, yeah, I had this idea that markets were ‘markets in ideas’ and you could have this laboratory for testing your theories about the world, battle them out in the domain of investment markets. And then like you said, I sort of spent this time as a sell side economist. Then I was a portfolio manager for a little bit. These days I’m a buy side strategist. But I’ve always worked in macro and asset allocation. And today my current role at HSBC Asset Management, like you said.

[00:04:59] Alan

And in that role you set the House View and you write a lot of thematic material, I guess, in terms of how the macro regime is evolving, etc. I mean, day-to-day, what does that look like, I guess, speaking to a lot of different types of investors, is that it?

[00:05:16] Joe

Yeah, so, we are a global asset manager. We manage US$850 billion over 20 locations worldwide. My responsibilities sort of divide into three different zones.

Firstly, working a lot with the research analysts and portfolio managers in the UK and then around the world in our different manufacturing centers, helping them with decision support. We often call it investment decision support; you know, macro perspective on events, helping think about alpha signals or making them aware of some of those macro risks.

And then, like you say, a big part of what I do is traveling to see investors in different locations, talking to the media, getting to do podcasts. We call it Thought Leadership, which is quite a grand title, isn’t it? I do my best to live up to that label.

And then the third part I do is helping my boss, the global CIO, coordinate and look after the global investment platform; so, sort of variety of management and leadership responsibilities that go with that. So, it’s pretty varied, actually. I get to do a lot of very different things and meet a lot of very interesting people.

[00:06:29] Alan

Very good. Well, I mean, we mentioned kind of your work on kind of thematics and kind of the big picture. So, probably the obvious place to start. I mean, most people, myself included, you know, reading your work, we’re all in this view that the macro regime has shifted somewhat in the last number of years versus the previous decade.

Maybe just to give us a sense on, you know, what do you think are the most important elements of that regime shift and the aspects that are most pertinent to the investment culture today?

[00:07:05] Joe

Yeah, I mean, that’s a great question to start with.

I think it’s helpful to think about where we’ve come from and then where we are in and maybe moving towards, because I draw a big distinction between the environment that we found ourselves in in the post financial crisis world versus where we are today. (And it maybe even predates the financial crisis to a certain extent.) But the environment of the 2010s was very much one of ‘flexible supply and demand’ as the key driver of perturbations, volatility in the macro cycle. So, we sort of ended up in good growth or bad growth environments, depending on how events were playing out. But all of the while it was low inflation; deflation, not inflation, as the primary side of the probability distribution, that we were worried about, as regards inflation.

And the reason that environment came about is because supply was abundant. The geopolitical situation was very stable. We were coming to the end of the phase of hyper globalization, but still in a very globally connected, extended supply chain situation. Demographics was very favorable in terms of the integration of the global economy as well as, of course, tech – a big part of the story.

And now, if we contrast that with where we’re sort of moving to and maybe heading towards, at least three of those following winds which kept inflation low and kept the growth environment strong, are becoming more headwinds. So, tailwinds to headwinds, particularly around the tricky situation in geopolitics and global economic fragmentation, particularly around what’s going on more broadly in globalization, as that shifts to regionalization, something particularly we’re seeing in the Asian trade data especially, but is also a phenomenon elsewhere. And also, demographics shifting, as working age populations decline, everybody is concerned about Japanification all of a sudden.

So, that means that there’s a heavy burden weighing on tech and AI to kind of keep this benign growth inflation mix, which we’ve experienced over the last 20 or 30 years and in fact are still on the road. My worry is that we’ve entered an environment where supply shocks are a much more dominant source of economic fluctuations.

And what happens with that, Alan, as you know, is you get not just growth volatility, but also uncertainty, stickiness and spikiness in the inflation regime as well. And that has profound consequences for how we want to think about asset allocation.

[00:09:56] Alan

Yeah, it’s interesting. I mean I definitely kind of very much hear all of those points. And you know, when we came out of COVID, and then the war in Ukraine, these were themes you very much heard from policymakers as well, even central bankers talking about the supply constrained world. Now against that, obviously inflation has come down. Obviously, it’s still a little bit above target.

Would you say you can see all of these elements in the data now? Are these more things that you will see that will continue to influence the trajectory of inflation over time?

[00:10:32] Joe

Yeah, I mean cyclically we’ve seen some stickiness in inflation, haven’t we? If you look at the data, in particular for Australia or the UK or the US (those Anglo Saxon economies, if we can call them that), inflation does seem to have got a bit stuck. I mean if you asked to guess what the inflation target was for those central banks, just by looking at the inflation data, you’d guess 3%, you wouldn’t guess 2%.

And I guess the environment I’m envisaging is not something that that’s particularly dramatic in terms of really decisively changing the inflation trend. It’s more of a nuance. So, what I would say is that the 2% inflation, which had been a bit of a peak during the 2010s, central bankers were struggling to get to 2% inflation – serial undershooters of the inflation target. That becomes more of a flaw in the way that I would think about it now. It means it’s a bit subtle. It’s a nuance rather than something more dramatic, suggesting that it’s going back to the ‘70s. That would not be the way that I would want to characterize the situation.

And I think you are seeing elements of that playing out in the data. We have had a little bit of a puzzle, I think, for many economists, this year, about why the tariffs in the US are not playing out more obviously in the key CPI readings. I wonder if actually what’s going on there is a little bit of a delayed effect that could come through in 2026.

Some of the economic research, that we’ve been quite persuaded by, suggests that most of the tariffs, about two thirds, have been affecting profit margins and about one third has been passed through into the inflation data. Now, as policy uncertainty slips away, tariff uncertainty falls away, all of these economic policy uncertainty measures are dropping quite quickly now, firms might regain a little bit more confidence, a bit more pricing power, and suddenly we see a bit of a delayed kick-on in terms of how tariffs are playing out.

So, I think it can be a term theme, a 2026 theme, particularly with policy impulse positive in 2026. I like the way that you phrased it at the start because it is, as much as anything, the way that we want to try and understand the economic regime as being one of sticky and spiky inflation. And that’s quite different to what we’ve experienced in the past.

And I guess we’re going to talk about it, but it has big effects in terms of thinking about bonds, and currencies, and stocks, and all the asset allocation decisions as well as.

[00:13:02] Alan

Sure. Well, we are recording at the end of November. It’ll be out in early December. It is the time of year where everybody, every strategist on the street has their 2026 outlook. Now, you did talk about positive policy impulse, so that maybe suggests that you do see some positivity coming where we’ve had, from the data we’ve seen (obviously the data is very patchy at the moment), the general sense is labor market weakening in the US and some downside risks to growth. But looking ahead, it sounds like you’re a little bit more upbeat on the outlook. Is that fair to say?

[00:13:34] Joe

Yeah, we’re still taking a moderately pro-risk allocation in how we’re building portfolios. And a lot of that is connected to a sense that the most likely outcome is a bit of a ‘muddle through’. Policy impulse is positive. Next year we’ve got Fed cuts, not lots. And I think they’re going to be constrained a little bit by this sticky inflation backdrop, but still a cutting environment. Tariff policy uncertainty is falling. The fiscal story and what’s going on in the industrial policy side are really big boosts to growth. So, I think a lot of people have looked at the AI boom, what’s going on there. But it’s all the derivative sectors as well, where you’re seeing a big investment boom. And all of that is important.

I guess what’s different versus maybe what we’ve become used to is how a faster cadence of growth might begin to generate inflation pressures a little bit faster than many analysts are expecting. So, that’s how we’re sort of thinking about it in the central scenario. What I would expect, alongside that, is that growth comes together a bit more globally.

So, the US exceptionalism idea has been this story that US growth has been the big relative winner. Markets of course going with that too. But as we look at the GDP scenarios for 2026, and also think about consensus around profit expectations as well, there is a sense that those expectations seem to be a little bit more globally aligned. Europe, China picking up much more. US relative advantage, slipping away a little bit. And that’s quite important because it speaks to something that we’ve been positioned for and thinking about in investment portfolios, which is this broadening out of stock market behavior.

So yeah, reasonably constructive in terms of our core scenario. I mean we run a few different scenarios. Of course we can talk about the risks. But the core scenario is one where we think that policy impulse is important. There’s a little bit of an inflation challenge, cyclical Inflation challenge, that comes alongside that. But this idea of a broadening out of market performance can mean that there’s still quite a lot for investors to look at and think about in 2026.

[00:15:46] Alan

And obviously, from a markets perspective, but it’s not totally removed from the economy, it’s been an important driver of the economy as well, has been AI and AI spend. More recently we’ve had some, I guess, reassessment of the merit of the amount of spending and the return that ultimately will be accrued, and also, from an earnings perspective, future questions on I suppose the durability of those revenues.

Well, you know, from an economic perspective, how do you see this, and also from a market perspective? Some people draw the parallels with the mid-‘90s. That was a different era. That was in the old regime. Do you see that kind of parallel, at least from an economic valuation or an equity valuation perspective?

[00:16:42] Joe

Yeah, it’s a great question. I was asked the other day which year the current situation is most like. I thought it was a really fun, interesting game to play because there’s so many parallels with the ‘90s.

I was re-reading the old book by Michael Lewis, The New Thing. I don’t know if you’ve read that one. But he chronicles the .com story in typical Michael Lewis fashion. It’s a great read. And going through that now, you can sort of see the similarities between that era, the economists writing about endogenous growth, productivity story, all of the investment excitement around the .com mania as well.

So, there are a lot of parallels with the late ‘90s. I mean, I think the big differences are around market valuation, maybe also the difference around what we see in terms of the broad global growth environment, the economic trade environment. And this notion, that I mentioned at the start, with the way that I would characterize the system is with a little bit more volatility, uncertainty, shock behavior coming from the supply side of the macro system as well.

So, in a way you’ve got this slightly strange blend where some parts of the economy are looking a bit like the ‘90s, other parts may be bit more like the ‘60s. And economists have talked a little bit about the K shaped economy all year where you have this lopsided nature to growth. Some sectors really doing very well and winning, other sectors struggling a lot more. So, I think that’s a nice way to think about it.

In the very near term, I’d certainly see the AI theme as a big investment boom. We can see that very clearly in the economic data, the excitement around data centers, the spend on data centers is overtaking more conventional forms of investment.

The first half of the year, the US economy, all of the growth pretty much is explained by data center, software, IT tech, and investment. So, there’s very clear sort of ‘shovels in the ground’ investment going on. Then the sort of economic question is how long does it take before the supply side starts to react to all of that in a more positive way?

Where’s the productivity story? Is that coming through in the data yet? A little bit, but maybe not quite in the really big way that tech optimists expect. And that’s when you get the more disinflationary force.

So, 2026, it still feels as if we’re putting heat into the economy, it’s going to create a little bit of cyclical inflation. But the question later is whether or not the AI theme is really a big positive supply shock. And of course, a lot of that is going to come back to the idea of how much labor it displaces as well. So, there’s an awful lot to think about. And then in markets too there’s many dimensions around index concentration, relative performance in different countries, to reflect on also.

[00:19:44] Alan

I mean, obviously we’re talking very much from a US perspective in terms of the impact of AI on GDP and the kind of the fiscal impulse. Outside the US, obviously, Europe, we’ve had the loosening of the debt break in Germany and a bit more optimism on growth.

I was at an event, I saw Isabel Schnabel speaking last week or the week before, saying she thought things look pretty stable in Europe and, if anything, upside risks to inflation. And then obviously in China and Asia, where you spend a lot of your time, a different growth dynamic.

So, I mean, maybe taking the Asian perspective, China has been muddling through, I guess, to use your expression. How do you see China’s growth trajectory and in the context of the overall emerging markets and Europe as well, taking the kind of global perspective on growth and not just the US?

[00:20:40] Joe

Yeah, I mean, it’s really interesting to reflect on what’s going on in Asia. In the markets we’ve seen super strong performance in Asia and China in particular. But so much of that is coming from the re-rating of the stock market, and then the currency effect. Actually, not that much is coming from profits growth. It’s the US where you’ve had the profits growth and then a little bit of re-rating. But that combination, if you like the structure of the return for investors in 2025, it’s a really interesting juxtaposition.

My expectation, in 2026, is that if things keep going, and the show stays on the road, then that distinction has to address. It has to be more about macro fundamentals, profit fundamentals coming in to make that performance of Asia stock markets, global stock markets, sustainable. So, we call it ‘role reversal’, Alan, in our investment outlook. You always want a jazzy name for the investment outlook.

But the story in China, I think, is consistent with that. I mean, growth trends look resilient in 2026. There’s still this big focus around policy support. Not maybe what we saw in the aftermath of the financial crisis (the big bazooka approach to industrial policy), but a very targeted policy stimulus, including fiscal support for consumers, which is a big, I think change to maybe what we’ve seen in recent years, last decade or so.

It’s very clear in Asia that the trade environment remains a challenge. We’ve done some work looking at export share, import share of Chinese economy. And you can see how the trade destinations are changing in the context of US trade policy, trade fragmentation. There’s much more regional focus around trade now. So, that pattern of a more diversified export market, much greater emphasis around regional trade integration, and the Chinese industrial policy focused on developing a really competitive advanced manufacturing sector and they’re sort of at the heart of it.

We’ve just had the new five-year plan. So, that’s kind of interesting because it puts fiscal policy on a pedestal. I mean, maybe we’ve all learned this lesson because in the west we were so absorbed with monetary policy as the only tool of macro stabilization for so long. Western policymakers seem to have kind of discovered the bigger focus which is dominant in Asia around industrial policy. But the China five-year plan really emphasized tech innovation, scientific innovation, it emphasized economic rebalancing. So, a bit more of a focus on the consumer rather than just investment and the business.

And we’ve got this funny phrase that you may have seen, anti-involution, which is very popular in Asia. Essentially policies to address the big challenge around overcapacity, which is still a big problem for China. We’re stuck in deflation. It’s now the longest stretch of deflation since the Asia financial crisis, if you believe it. So, that’s an important element of the story to watch. But yeah, on balanced growth it looks pretty resilient, I think, in 2026. We are expecting an exit from deflation gradually to play out as we go into the early part of 2026. And then the hope, in connection to all of that, is that fundamentals can do more of the heavy lifting in terms of driving market performance in 2026 because there’s been a big reliance on re-rating and currency to drive the stock market this year.

[00:24:29] Alan

I mean you touched on the markets a little bit, but I mean bringing it together, it sounds like growth in the US is okay, maybe a little bit of an impulse. China is okay. There’s a lot of concern out there about AI, about the markets. But it seems like, from an equity perspective, you’re not overly concerned about how far things have gone and seems a reasonably positive perspective. I mean, I’m putting words in your mouth, but is that how you see it?

[00:24:54] Joe

Yeah, I mean look, you’re always, in my line of work, you’re always thinking about what can go wrong, where the risks might be. I mean one of the biggest risks, of course, is price evaluations. We’ve had this big phase of re-rating in stock markets, credit spreads moving to multi-decade lows. It’s really important to think hard not just about what’s going on in the economic environment, but also in terms of market valuations there.

In my philosophy, they’re the sort of two key variables that are helping us understand what prospective returns in 2026 (but even beyond there, on a multi-year horizon) might look like. So that sense around, are we priced for perfection in markets, is a big thing that I worry about.

And you mentioned some of the other things to be concerned about; if growth sort of stalls out, or if the AI trend really kicks on again and we get another phase of US exceptionalism. But our central scenario is really looking for this idea that the stock market trends, investment trends can broaden out.

If growth comes together, there’s a little bit more inflation. So, we need to be thoughtful about how we maybe diversify our diversifiers a little bit more. But an investment case that’s quite strong, particularly for E-Fi and especially for emerging markets, which is our kind of highest conviction view at this point, looking ahead to 2026.

[00:26:28] Alan

We touched on the 1990s and parallels, and obviously differences as well with respect to tariffs, trade environment, etc. I mean, the other glaring difference is debt and deficits. I mean, if you go back to the mid/late 1990s, well, in the late 1990s US ran a surplus I think by 2000. So, I mean, that’s a massively different backdrop from a debt perspective.

But obviously we’ve seen some issues, wobbles I guess, in the UK bond market. We’ve had a re-rating of yields in Europe. The US, it’s been up and down around 4.25% since what, three and a half years now. So, despite the kind of trajectory of debt levels in the US the markets have been stable. Is this a risk? Is it something that heavily weighs in your mind when you’re doing asset allocation or how do you think about it?

[00:27:22] Joe

Yeah, for sure. I mean you’re right. The contrast with where we were in the 90s is remarkable, isn’t it? I mean, there was an intellectual debate about whether or not the treasury market should be sustained because the public finances was in such a good situation. The argument was whether or not the treasury market should be sustained as part of providing global liquidity services to the rest of the world. Crazy when you think about the context of today. What a huge difference.

But yeah, look, you’re right, Alan. I mean, this has a bearing because I think it’s an important economic megatrend, mega force to understand when we do longer run investment modeling, thinking about debt, demographics or globalization, these are really important trends to be on top of. But in the here-and-now we’re thinking, if the growth cycle is going to falter, what could be the drivers of that?

And there’s the old joke among economists, it’s not the funniest joke. I fear I might have set it up a bit too much now. But there’s the joke that the economic cycle doesn’t die of old age, it gets murdered. And normally what economists are thinking is the central bank becoming very hawkish. But the bond market can also play a really important part there as well.

So, I think one of the main areas, in terms of the mechanism, where growth might falter and again investors get very fearful about recession, which is not our base case, but the mechanism by which that plays out I think could be through the so-called crowding out; huge issuance of credits by AI and tech and data center investors that could create pressure on credit markets and raise cost of capital, challenge financing right across the system. Or equally, in the context of the government finances, public finances, debt ratios exploding. Do we see some challenge around a misbehavior of ultra long term government bonds?

I mean, so far that’s been contained to Japan, Europe, and France in particular, quite a lot of discussions with investors in the UK around the budget, what might happen, what might happen there. And I think if we look at the part of the yield curve that’s been most affected, it does seem to be the ultra-bond rather than 10 year, it’s a 30-year sort of problem in the main. But one feature of markets that’s been really interesting to me this year has been how long-term bonds, at the 10 or 30 year maturity, have been either sticky or moving higher despite the fact that we’ve had rate cuts.

I found that really interesting. We’ve got a few charts on it in our chart pack for the investment outlook. But it’s another one of these stark differences versus the environment of the 2000s or the 2010s, because in that phase you had Greenspan or Bernanke complaining that the long bond was just falling, and falling, and falling, even when they were hiking rates. And now you could see Powell or the new Fed chair next year kind of making the opposite through the looking glass argument.

“I’m cutting rates, I’m cutting rates, boss.”

But the long bond is misbehaving. It keeps going higher. Greenspan and Bernanke called it the ‘bond yield conundrum’.

I’ve been calling it the ‘reverse conundrum’ today because everything seems to be the other way around.

So, although what’s interesting is that the areas of stress in debt markets have been a little bit country specific, and it seems to be quite focused on a particular part of the yield curve, I think the underlying dynamics where we’re seeing steeper yield curves, rising term premium in bond markets, that all looks to me that it’s quite consistent with a concern around debt, a concern around fiscal dominance, a concern around fiscal inflation risks coming back to the fore in a way that we just were safe to ignore all of that for the last 20 years prior to the kind of the COVID pandemic.

[00:31:39] Alan

And I mean, you mentioned the conversations with investors and a big talking point, in relation to this regime shift, has been the end of the 60/40 or certainly a question around the role of bonds in portfolios. Obviously, from a fixed income perspective, yields are higher than they were in the old regime, which makes them more interesting.

But as you say, if we’re into a sticky inflation world, and if we’re into a world where if they cut rates and yields tick higher, then duration doesn’t serve its same role as in the past. So, I mean, from an asset allocation perspective, what are you suggesting then in relation to how to use fixed income in multi asset portfolios?

[00:32:26] Joe

Yes, so you’re right, duration doesn’t play maybe the same role that it did always. I mean, maybe investors were a bit spoiled during the 2010s, 2000s because diversification was reliable, and cheap, and easy to access, highly liquid at the same time. So maybe we have to work a little bit harder for that now.

Now, that’s not to say that there’s not things to do in bonds. I mean, one of the markets that we’ve been actually quite interested in has. Been the UK gilt market. Not because the public finances or the productivity story, but because the fiscal premium looks really outsized. The term premium looks really outsized relative to what we normally expect. So, sometimes there can be a carry argument or a valuation anomaly argument for parts of the bond market on a tactical basis, almost, even in this environment of tricky fiscal dominance, tricky macro situation and supply shocks.

But I think in general, what I would say, Alan, is the idea of diversifying the diversifiers, working a little bit harder to try and find risk mitigation or portfolio resilience is probably the way that I would try and approach that. I mean, one thing that stands out in our investment outlook is the case for hedge funds or alternative investment strategies. Because when you look at the performance of hedge funds in phases like the ‘80s or the ‘90s, it’s the era of global macro investors in some respects, it’s a much stronger return profile and a really important contribution for overall risk return at the portfolio level.

And then you have this kind of fallow period where many hedge fund strategies, macro multi strategy, found it a lot more difficult when you’re in the monetary policy-on-steroids era, low inflation era.

So, if things are reverting back to a regime, similar maybe to the ‘90s with little bit of 1960s mixed in as we were joking earlier, then some of those areas in the hedge fund space, look interesting too. I mean the other idea (I’m not sure how you’re going to react to this one) is a lot of our work does point to emerging markets really growing up. So, in the investment outlook I make the joke that it’s like Dirty Harry: “Do you feel lucky?” Because emerging markets have been lucky in 2025 with the dollar move, but they’ve also been good.

So, it’s not just luck, it’s also self-made luck, if you like, because the macro reforms, the financial reforms seem to be really having a big effect. And if we look at bond markets, emerging market bonds, even including the currency, are a lower volatility than developed market bonds now. And we see a similar pattern in equity markets as well. In fact, some of the allegedly most risky equity markets, like frontier markets, seem to have lower volatility than MSCI World, or European, or the rest of emerging markets.

So, there’s something going on in a diversification on a country-by-country basis within the EM indexes, which seems to provide much lower volatility than we might conventionally assume. That’s not to say they’re necessarily hedging tools, but when we’re a little bit starved of our old reliable workhorse, reliable diversifiers, and we’re having to look in different directions, I think it does require a little bit more of an open mind to think about different parts of fixed income, different parts of alternatives, especially something like hedge funds, maybe private markets too. And even emerging markets, which stereotypically is the gung ho beta bet, that can maybe play a role, as well, particularly if the economic cycles are a little bit desynchronized.

[00:36:36] Alan

Yeah, and is that, as you say, index composition kind of sector exposure? Are you getting more financials, more commodities in emerging markets, less tech, presumably? Is that the less volatility? I mean, the great question always used to be, will we get emerging markets genuinely decoupling?

I mean, if we have a major economic downturn, or an equity downturn in the US, which generally drags down the rest of the world, I mean… immune would be a strong word, but can emerging markets decouple in a scenario like that, do you think?

[00:37:13] Joe

Well, the spillovers, the sensitivity to the macro cycle does look like it’s less than we might stereotypically or historically have seen. And that comes through in a lot of the work that we’ve done. It also comes through in the recent IMF World Economic Outlook. They’ve been writing and looking at it as well.

So, the kind of drawdowns in GDP, the damage to risk markets does seem to be a little bit less that than maybe the old approach would suggest. And, of course, a lot of that is really connected to maybe more developed and improved reformed economies, financial sectors, and a much deeper domestic investor base as well. So, you don’t end up with this classic, stereotypical emerging market, doom loop: the Fed hikes rates, capital rushes away, and it tightens financial conditions within emerging markets. They have a little bit more self-determination than I think what we saw in the past.

The other remarkable thing is that even within the emerging markets complex, you end up seeing quite idiosyncratic things going on within the index or across the region. So, China versus India is the best example, and it maybe quite salient for everybody listening as well. India has had a poor year for performance in the stock market in 2025 after multiple gangbuster, very strong years. And China is the big winner in 2025.

Now, historically this idea that India and China can have slightly mirror image performance, that’s very strange. If you look back during the 2010s and look back even further, the historic tendency is for those indexes to be highly correlated. And so, this goes back maybe to a little bit of what’s going on domestically, but also what’s going on domestically in terms of the behavior of investors, and also how foreigners are accessing emerging markets as well. If everybody’s just buying global emerging market funds, or BRIC funds, then there is a forced correlation with those markets.

If, instead, there’s greater access awareness of country specific themes, greater access to country specific funds, then that can be a source of differentiation and diversification within the EM index. Which almost supports this idea of recognizing that economic policy, the stage of the cycle, the structure of the economy in India or in South Asia, which is very different to what you see in China and North Asia.

And so, some of those differences can really kind of come through in what we’re seeing in index performance. And I think that becomes more and more important actually rather than being just a short-term blip. I think it sustains because a lot of the policy in innovation or idiosyncratic measures that different countries may take in terms of their economic or foreign policy, that seems to be a direct consequence of the geopolitical environment that we’ve found ourselves in; the multipolar world as I call it and others call it.

That seems to create a situation where you can have greater differences, policy experimentation in different parts of the world. And that might mean, like you say, that you end up with slightly different dynamics depending on where you are in emerging markets. Not just reflecting sector composition but also reflecting like a country effect as well.

[00:40:58] Alan

Interesting. I mean, you touched on the tailwind for EM for the US dollar. I mean, the dollar has been an interesting story this year. Obviously, it started the year, and people expected a stronger dollar on tariffs. We got the tariffs, then we had a weaker dollar. Then there was a widespread pessimism about, yeah, look for the dollar. And we’ve had quite mixed performance since then. I mean if you look at the Euro, it had a jump up but it’s kind of been stuck at 115, 116 maybe for about six months now.

Dollar/yen, on the other hand, has kind of been moving higher of late in Asia the mixed renminbi was a bit stronger but kind of not doing anything too dramatic. But everybody had that chart in their reports at one point showing the, you know, the worst start for the dollar for the year ever.

You know I haven’t seen it for a few weeks now because obviously that story has quietened down. But it seems like that extreme bearishness has paused for the moment. I mean where are you on a multiyear basis?

[00:42:00] Joe

Yeah, I mean like you say, the cadence of the dollar has been quite different since the summer versus we saw in the first part of the year. So, maybe the first part of the year is that very clear, rapid decline in the dollar versus everything. That’s the debasement trade or the US exceptionalism reversing, it’s a story, very clearly. And it’s fizzled out, hasn’t it, in markets?

The dollar depreciation that we have seen since the early part of the summer seems to be more about the cycle, it seems to be more about the Fed. And then, as you mention, Alan, we’ve had a bit of a reversal going on more recently. We still find that the dollar is quite overvalued versus most currencies; a 15% to 20% overvaluation on our equilibrium currency modeling, now.

I mean, you know, you have to be a bit careful about valuation analysis when it comes to currencies. You might be okay with bonds and stocks but with currencies you have to be a little bit careful. But I do think it works at extremes. So, the question is whether or not that 15% to 20% mis-valuation or overvaluation is enough to kind of trigger the valuation elastic into coming back together.

The one reason why it might be is that policy does seem to be focused, again, on delivering a weaker dollar. That seems to be the message from Treasury Secretary Bessent. That seems to be something that the Fed is wanting to support. It seems to be aligned with that sort of rebalancing, adjustment on trade balances, and maybe supporting some of the big tech export side as well.

And some of the themes that I mentioned around growth coming together, if the bad luck that’s hampered European economic performance in recent years is easing, then European economic recovery, German fiscal support, Chinese growth (as we talked about) looks like it can be resilient and strong, around 5%, give or take. Then this idea of maybe some re-equilibration of growth around the world, that can also support a weaker dollar.

So, I mean our scenario is to expect it to be a little bit higgledy-piggledy from here, but to position for a modestly weaker dollar in 2026. That can still then, obviously, be a help for emerging markets and EFi capital flows downhill; some support in terms of financial conditions for rest-of-the-world asset classes. But it’s not quite the sort of dramatic end of dollar dominance idea that was quite popular among polite discussion in circles of economists earlier in the year.

The one idea that we’ve had, which I can’t quite be certain of at this juncture, is how the dollar performs under a growth problem scenario. Because historically we’re used to not just a multi decade dollar bull market, but we’ve also had this kind of risk mitigation property of the dollar. Sometimes people call it the dollar smile.

So, you get a positive return for the dollar in a risk-off, a positive return for the dollar in a situation where US growth is outperforming the rest of the world, and it’s just that middle bit where the dollar is weaker which kind of supports rest of world economic and market performance.

The question in my mind is what’s happened to that left hand part of the dollar smile? Has it become more of a sort of a smirk? And that could be then something to watch and think about. It brings us back again to this Idea of where the true risk mitigators and diversifiers are today.

So, they’re the things that we’ve been thinking about. But yeah, we’re in the camp of multi-year dollar weakness. I think you’ve got to be kind of realistic about the rhythm of that and the extent it can play out. But the key thing is that policy seems to be lining up behind a valuation signal, and I think that’s a reasonable basis, then, to give some support to some of the investment themes in emerging markets and outside of the US markets as well.

[00:46:38] Alan

Yeah, I mean, you mentioned policy. I mean, part of the theme earlier in the year was maybe policy credibility and obviously we’ve had attacks on the Fed and suggestions that we’ll see a less independent Fed. And we’re getting into the end of the year, so the time frame and how all of this plays out is getting a bit closer in terms of likely replacement for J. Powell. So, any thoughts on that? Who’s your personal favorite or who do you think the most likely replacement is?

And, and you know, there’s two schools of thought. One is this is going to be highly significant. The second one is not going to be that significant. It’s one person, one voice at the table. What do you think in terms of the significance?

[00:47:27] Joe

Yeah, I think, I mean it’s exciting, isn’t it, for central bank watchers. These things are always interesting to follow. I’m a bit of a nerd, Alan, when it comes to tracking central bank speeches. And I think, like many economists, we have been in the market. There’s been a significant attention to the presentations of Waller alongside the other core FOMC members over the last sort of six months, I would say in particular. And those speeches are always very thoughtful and interesting, so, always interesting to read. The other candidates that have been discussed are a little bit more, maybe, unknown to investors, although all very high profile in their own rights as well.

How much of an effect can it have in 2026? I mean it might be worth one cut if you get a particularly dovish Fed chair. Our scenario isn’t so far away from where the market is. Something like 3.5% Fed funds by the end of 2026 would seem reasonable, so, sort of two or three cuts. But I find it hard to see that it’s going to decisively pivot everything on a dime.

Like you mentioned, it’s one vote in a system where dissent and disagreement is increasingly something that investors expect and look for in the minutes. So, I think it could be worth a little bit of extra easing at the margin, if you get a particularly dovish leader chair at the Fed. But I’m not sure that it completely decisively changes everything in 2026.

I mean, Central banks, we know, are an arm of government. This idea that economists had that they were just independent technocrats, like a monetary policy council or a fiscal council, as if they can ever be completely, fully technocratic and independent. It was always something of a non-starter, from my perspective. But you still have a situation where there is operational independence, which is of course the critical part of the story, to deliver good growth and inflation outcomes.

I mean, the other thing I’d mention is that economists don’t really know too, too much about populism and how populism plays out. But the playbook that we have from Latin America and other economies does always point to an idea around some challenges and growth, and this idea that institutions are under scrutiny. And so, to a degree, what we’ve seen in 2025 isn’t really that surprising. It’s very much a sort of a classic playbook.

I think where it leaves us is reinforcing this idea that that 2% on inflation is more of a floor now, than a ceiling. It doesn’t have to be particularly… We

don’t have to be particularly shrill in the inflation scenario that we might want to assume, but just to sort of reinforce that idea that stickiness and spikiness are probably good bywords, good adjectives to describe the inflation process now, which is a marked difference relative to what we’ve become used to, and the environment that we’ve grown up in as investors.

[00:50:59] Alan

Yeah, I mean, absolutely. The one asset that maybe has reflected all of these kind of themes this year has been gold. I mean, it’s an asset that polarizes strategists, and economists, and asset allocators. Some people love it, some people have zero. I mean, in your model portfolios, is there a place for gold and how much?

[00:51:23] Joe

Yeah, we’ve been big fans of gold, Alan, so we got that one right. And so, that’s been an important theme, both in terms of it being in strategic allocations as an extra layer and element, but also to reflect the fact that we had some concerns around dollar dynamics and what might happen. And we’d seen in some of our analysis, looking at central banks and sovereign investor positioning, you can see that movement more toward gold and some diversification to other currencies as well.

So, across a lot of the metrics that we’ve been tracking, across a lot of the discussions that we’ve been having with investors, I’ve been having with investors around the world, it’s really come up as a kind of key theme.

And as you say, it’s probably the clearest example of some of those ideas really coming into markets and playing out strongly. The other one I’d suggest is the stock/bond correlation because that stock/bond correlation has really shifted materially. Obviously it depends a little bit how you measure it, what the look back period is, what kind of time horizon you’re looking at. But it’s another reminder that stock/bond correlations are moving into positive territory. That’s telling us something about how many investors are thinking about inflation. The co-movement of those asset classes is really reinforcing that dynamic that you’ve seen behind the gold price action, the debasement trade as it’s been talked about.

And it’s a remarkable situation. Of course, all of that’s happened at the same time the stock market has been in bull market all over the place. So, they’re a quite interesting set of co-movements, correlations in parts of asset markets.

[00:53:20] Alan

We touched on how you speak to lots of investors, so, that gives you a good vantage point around sentiment and where people’s minds are. I mean, do you think, generally, (it’s very hard to kind of broad brush statements), do you see a, generally, pro risk, positively positioned investor base that you speak to or are cash levels a bit higher? Is that going to be a positive or would you say people are overextended, or neutral, or how would you categorize positioning from your vantage point?

[00:53:53] Joe

Yeah, I mean, I think it depends a little bit sector to sector, investor type to investor type. But there does seem to be a bit of a nervous equilibrium, a fragile equilibrium, maybe, to the outlook. Because this idea that we talked about where the economists have been thinking about the K shaped economy. What happens next? Does the top end of the K move higher still? Does the bottom of the K fall away, or could it catch up a little bit? Many questions about how the economic system is going to play out.

I think many investors are worried or focused on an idea of a sustained big AI bubble dynamic, also fearful, at the same time, in the same conversation, without skipping a beat in the articulation of their thoughts, about the slowdown, the labor market data, and whether or not the US economy is hitting some sort of stall speed that then affects what goes on elsewhere. So, there’s some dissonance and anxiety in a situation which is pretty radically uncertain, really.

So, a lot of what we see with positioning may be thinking about something that is still modestly pro risk is tentative, is tentative, and as you say, cash positions, and a heightened awareness to news, and sensitivity to sort of sticker shock or market dynamics, I think that’s all very much part embedded in the conversation.

And this is why some of the dynamics that we’ve been seeing with AI volatility, for example tech volatility, is really interesting. Tracking some of the technicals, how that’s going to play out, is it going to evolve into a much bigger story? There’s clearly a lot of nervousness among the investors that I talk to, but also a recognition that, while the growth cycle looks okay, investors mostly want to stay invested and look for maybe different sectors, different geographies to express their view, maybe with a little bit less valuation risk.

So, thinking about Asia tech rather than US tech, for example, could be interesting, looking at neglected equity markets in Europe, thinking about the highest quality parts of private credit rather than a generic allocation focus on direct lending, looking at new ways to hedge portfolios. We talked about hedge funds. That comes up a lot with investors who are thinking about the asset class in their investable universe.

So, certainly an acknowledgment of different scenarios and recognition that a lot can potentially happen. And the kind of unique situation that we’re in today where, you know, if macro trends lurch to the downside or to the upside, it would have big effects on portfolios and big effects on markets. And at the same time, because it’s part of the conversation and the discussion, it almost wouldn’t be that much of a surprise. Quite interesting.

[00:57:17] Alan

I know you publish your own capital market assumptions and we’ve talked a lot about kind of the view this year, next year, I mean taking more of a kind of a multi-year, as you say perspective. We’re in a new regime. Valuations are high on a five to ten-year view. I guess you hear from a lot of people, expect lower returns in equities or US equities, look for opportunities elsewhere. Is that your thinking? I mean you sound positive on EM. Is that the core, I suppose, high conviction view or anything that you would particularly highlight if you’re constructing a kind of a portfolio from a five to ten-year perspective as opposed to for the here and now.

[00:58:00] Joe

Yeah, thanks Alan. I mean this is a really big part of the work that we do. It’s something of a passion project for me as well, I must confess. We have higher cash rates because of the sticky inflation on a multi-year timeframe. So, rate cuts in the very near term, but a higher sort of resting rate for rate for cash rates. And one of the things that does is then play out right through the asset spectrum into bonds, and credits, and equities, and elsewhere.

Importantly, it means that while equity returns still look okay in nominal terms, the reward, the equity risk premium for taking equity, is a lot more skinny than maybe we would expect. We have equity risk premium in the US starting with a 2 now, which is unusual. We’ve got down to a 0 in the .com mania. So, you can see the sort of valuation adjustment investment could still continue but normally we’d want to see 4% equity risk premium, 4% and a bit equity risk premium.

Where we do see high returns is very much in the EM space, which is coming from asset risk premia being a bit more elevated. Cash rates are, in some instances, decent as well. And then also the currency element, which I think is a big part of when we think about the long-run work, we’re often thinking about whether or not the spot currency is going to outperform the forward rather than necessarily making a bold view. But the currency element does seem to be a big part of the story.

Virtually all of the emerging market currencies that we study in our work are showing material undervaluation versus the dollar. And on a medium-term view I think those valuation rules of thumb are probably a decent guide. And then there’s a number of areas in the alternative area which I think look interesting for return enhancement. So, we might look at something like direct lending still, some safer parts of private credit. Private equity has been a bit neglected, but there seems to be an improvement in terms of the private equity market in general. Returns still look okay.

It’s quite aligned with some of the broadening out type of idea in the buyout private equity space. And that’s how we model it as well, thinking about it as a derivative on different parts, different factors in the equity market. So, that’s kind of interesting too.

And then, at the sort of lower risk end, we see some of the phenomenon that we mentioned at the start, credit spreads at multi-decade lows. In some instances, we’ve seen credits trading through government paper. We’ve got higher risk premium on bond markets because of an expectation that some of those fiscal risks are going to come through.

So, it is very much a case of thinking quite hard about how you position that safety part of the portfolio. Which is why some of these other areas of asset markets, thinking about maybe Asia credits, or emerging market credits, or hedge funds, or infrastructure, come into that sort of safety part of the portfolio.

It’s very much similar to what we talked about, moving or making the argument that moving to a more highly uncertain, complex macro environment, a multipolar world, if you like, kind of means you’ve got to move to a multipolar portfolio as well and think about building portfolio resilience with a number of different asset classes to try and bake in some of that ‘all weather’ type characteristic which we want to harness in our multi asset portfolios.

[01:01:38] Alan

Very good, just conscious of time, we’re just up to the hour and we do like to ask our guests for any advice they might have for people who are interested in macro, or getting better at macro, or things you’ve read. Obviously, you mentioned the Michael Lewis book, which I haven’t read, so I made a note of that one to go and look at. But anything else that you’ve read that’s been highly influential in your career, or advice you’ve got and things you’d pass on there to people?

[01:02:04] Joe

Yeah, I mean I am a big sucker for books, Alan. I read, recently, just finished Breakneck by Dan Wang, which is all about the Chinese economic mirror miracle. And Dan Wang is quite a well-known analyst writer on China. That’s a terrific book. I’m not really surprised to hear that it’s one of the top nominations for Economics Book of The Year.

It’s certainly the best new economics book that I’ve read this year. And he goes through some key aspects of China regional development and China macroeconomic development. Thinking about technology, thinking about how they’ve set up some of the manufacturing success stories, but also thinking about some of the other areas of recent history; the zero COVID policy for example. So, that’s fascinating if you’re interested in China macro.

I suppose, historically, it’s maybe a lot of books that you know, things like Market Wizards which I always recommend to our graduate cohort. Mean, I love that book. On the economics side, there’s a terrific book by Dani Rodrik, at Harvard, called Economics Rules which looks at how you can apply economic models to thinking about the world. This sort of is like the idea of the stock market being the ‘market in ideas’ that I mentioned at the start. So, Rodrik kind of goes through all of the different schools of economic thoughts and shows you how all of the models are relevant. You’ve just got to pick the right model at the right time. So, I really enjoy stuff like that and often that’s quite a nice book for people who are maybe coming from an economics background, to start thinking about how to apply some of those ideas to the real world.

But yeah, big sucker for books. Big sucker for Substack as well, Alan. So, always following your Substack.

[01:03:56] Alan

Good stuff, good to know there’s some readers out there.

Great. Well listen Joe, appreciate your coming on today. It’s been great to get your thoughts on everything from global markets to global asset allocation. And obviously listeners can follow your work. I’m sure they can find you pretty active on LinkedIn, and social media, and you kindly also share a lot of your HSPC publications on those platforms too. So, keep an eye out for Joe’s work because obviously it’s a very macro driven world we live in today.

But from all of us here at Top Traders Unplugged, stay tuned and we’ll be back again soon with more content.

[01:04:36] Ending

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