Can Generative AI Overcome Questions Around Scalability and Cost?

Economic

Summary:

With the world’s biggest companies racing to build the most sophisticated artificial intelligence, questions about how far and how fast the technology can be scaled are coming into focus, according to Goldman Sachs Research.

The advent of generative AI has created a surge of excitement about the future of the technology. Unlike other types of AI, gen AI can create its own outputs in natural language. Because it’s “multimodal," it can also generate responses in other formats, including text, numbers, videos, and sound.

Large tech companies are citing initial use cases, and some enterprise players see scope for major productivity gains in certain areas such as code writing, which could make the most valuable employees even more productive.

However, the exact size of future economic benefits is the subject of debate. The cost of building gen AI at scale is extremely high, with big tech companies investing hundreds of billions of dollars — although the cost per query has come down considerably since the technology first launched.

At the inaugural Goldman Sachs European Virtual AI and Semis Symposium, 20 speakers — from CEOs and technologists to macro economists — came together to assess the prospects for AI. In particular, they discussed key topics including use cases, the total addressable market, challenges for further development and adoption of the technology, and implications for European hardware and semiconductors.

We talked to Alexander Duval, head of Europe Tech Hardware & Semiconductors in Goldman Sachs Research, about the main findings of the symposium.

What role are the large tech companies known as “hyperscalers” playing in the development of AI?

So far, US tech giants have been at the vanguard of generative AI use. They've been developing large language models, which they can use both for their existing business and also potentially in creating new business tools.

The symposium heard how the technology is generating a quarter of one hyperscaler’s code and saving meaningful engineering time for another. Broader use cases in the real economy include its use to predict the structure of proteins, and even to “de-age” an actor's appearance in a movie.

Those are striking examples. But it's worth bearing in mind that hyperscalers have been spending hundreds of billions on this. Together, they have spent around $200 billion on AI this year, and that will probably increase to $250 billion next year. Developing large language models can cost tens or hundreds of millions of dollars. And that's why at this symposium, we really wanted to look at whether it's feasible or desirable that the technology could scale to address many more use cases. These hyperscalers have a lot of free cash flow, and we are starting to see examples of use cases, but a number of industry observers believe that at some point we need to see a return on investment for a broader array of use cases and verticals.

Have any key use cases emerged for artificial intelligence in the broader economy?

Because generative AI is multimodal, it could theoretically apply to multiple fields: customer support, coding, medical analysis, marketing and many others. Given that there is a very significant level of investment in AI, the aggregate benefit of such use cases will need to be demonstrated in order to justify a solid return on investment. That being said, some participants at the symposium said that it might not be imperative for AI to scale in one particular area — in other words, a single key use case may not be necessary — as long as the economic benefits from all the different use cases are sufficient in aggregate. You could see efficiency gains across the board.

Some speakers pointed out there are a number of examples of very large successful tech businesses where you could argue that there wasn't a key use case at first. Take the example of ride hailing apps. There was already a perfectly good solution: Walking to the end of the street and hailing a taxi physically. But by leveraging software and network effects, you could create very large economic benefits, as well as benefits to consumers.

Is there still room for smaller technology companies to compete?

Some speakers at the symposium had interesting insights on small language models. At first, technology players were focused on building large language models — and those are still important. But there is also a trend of developing smaller and more efficient models.

Small language models are easier to fine tune, they may have lower energy consumption, and they can be customized to meet an enterprise's specific requirements in a given domain (such as legal, medicine, or finance). They’re also generally less expensive, because they're smaller and use less power.

Large language models will remain important, and tech behemoths have the resources, free cash flow, and balance sheets to drive the development of those. But speakers pointed out that there will be other, perhaps smaller players in the ecosystem who can innovate and develop small language models that will sit on top of those larger models. Some speakers thought this presented an opportunity for small companies to drive innovation at the top of the stack and highlighted the large number of companies being founded daily to do so.

Could the high cost of generative AI hold back development?

Training LLMs requires very high levels of capital investment. You need to build a data center, you need all the semiconductors — that includes both GPUs and memory chips — and you need hardware, power, and utilities. Speakers mentioned that the cost per query in some domains is multiple times higher than for a regular search algorithm.

That said, there has been steady progress on reducing costs. The cost of a generative AI query at some large tech companies has come down significantly since the launch of the technology, and a new gen AI company has said that revenue generated by the latest generation of LLMs exceeded the cost of training prior models. While some speakers stated there could be a risk that spending on AI could reduce if significant returns are not generated, the consensus was that hyperscalers will continue investing in the next few years. In total, Goldman Sachs Research predicts around $1 trillion of investment in AI in the next few years.

What are the other obstacles to scaling AI further?

There are a number of challenges involved in scaling AI. To build the technology, you need access to semiconductors, power, and lots of data.

Data is becoming a key question. We're getting to the point where developers have trained these large language models on practically all of the data that's out there on the internet. AI experts are trying to work out how to surmount this issue.

One potential answer is multimodal learning — where AI models learn by ingesting not only text, but also video and pictures. That will give them a lot more information. There are also stores of data which may be in proprietary silos — at research institutes or corporates, for example — and could theoretically be added to the corpus of data on which these models are trained. We also heard about the possibility that quantum computing will generate some high-fidelity data that could be used to train models.

The huge energy requirement is another bottleneck. Power generation is going to have to increase by at least three to four times by 2030. And one of the panels highlighted that the increased energy requirements from just the four or five biggest hyperscalers in that time will be equivalent to the current energy consumption of France. Fortunately, more advanced semiconductors may also bring better transmission infrastructure and more efficient power conversion. Efforts are also underway to make semiconductors more energy efficient.

What are the risks of adopting AI at scale, and how can we limit them?

The proliferation of AI has given rise to concerns about the ethics of its use. That said, our panels highlighted that enterprises and ethics bodies are monitoring the uses cases being developed, and suggesting guardrails to ensure that AI is not misused. For example, some speakers discussed how having a human familiar with the context of the specific task checking AI outputs reduces the risk of hallucinations having a detrimental impact.

Other risks that warrant further attention include AIs communicating among themselves (potentially in a language that humans can't understand), copyright concerns, bias, and security.

As such, speakers agreed that AI use may be increasingly limited to the least risky domains and conditional on safety features and human supervision.

How could European hardware and semiconductor companies benefit from the development of AI technology?

A number of European hardware and semis companies could benefit. In particular, the symposium learned about atomic layer deposition technology — a type of semiconductor production equipment that allows you to deposit materials on a silicon wafer very accurately in order to build a chip. One particular company in the Netherlands offers this technology. As these chips get more powerful, they need to be more efficient with space and power, so new designs of chips are increasingly leveraging atomic layer deposition technology.

Multiple participants also highlighted Europe’s capabilities in advanced semiconductor packaging, needed to ensure efficient use of space on devices. And lithography — the mechanism for printing transistors onto microchips — will also continue to advance, offering increasingly powerful processing capabilities. Europe is also the dominant producer of that kind of technology.

Finally, significant power conversion will be needed to run AI servers, and Europe has promising capabilities there, too.

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Warren Takunda

Economic

UK inflation has risen to its highest level in eight months, adding to pressure on the Bank of England to keep interest rates unchanged on Thursday despite a slowdown in the British economy.

Figures from the Office for National Statistics show the consumer prices index (CPI) rose by 2.6% last month from 2.3% in October, driven by the rising cost of petrol, groceries and an increase in tobacco duty in the budget.

The reading, which matched City economists’ forecasts, pushed the headline rate further above the Bank’s 2% target for a second consecutive month.

The ONS chief economist, Grant Fitzner, said: “Inflation rose again this month as prices of motor fuel and clothing increased this year but fell a year ago.

“This was partially offset by air fares, which traditionally dip at this time of year, but saw their largest drop in November since records began at the start of the century.”

The latest snapshot showed the average price of petrol rose by 0.8p a litre between October and November 2024 to stand at 134.8p a litre, while the price of diesel rose by 1.4p a litre to 140.5p. Air fares fell by 19.3% on the month, compared with a fall of 13.9% a year ago.

Threadneedle Street is widely expected to keep interest rates unchanged at the current level of 4.75% on Thursday when its monetary policy committee meets to set borrowing costs.

The Bank had forecast inflation would rise towards the end of the year after temporarily falling below 2% in September. Inflation has dropped from a peak of more than 11% in the second half of 2022 after Russia’s invasion of Ukraine fuelled a rise in energy prices.

However, there are signs of the economy losing momentum after gross domestic product unexpectedly fell by 0.1% in October. Business surveys also show that employment levels are falling at the fastest pace since the global financial crisis in 2009 outside the Covid pandemic.

Core inflation, which excludes volatile items including energy, food, alcohol and tobacco, also rose from 3.3% in October to 3.5% in November, marginally below a 3.6% forecast among City economists.

Andrew Bailey, the Bank’s governor, has said that how businesses react to the government increasing the rate of employer national insurance contributions (NICs) in the autumn budget is the “biggest issue” facing the economy.

Rachel Reeves announced in October that the rate of employer NICs would increase from 13.8% to 15% in April to raise £25bn for the exchequer, aiming to plug what she termed a “black hole” in the public finances left by the Conservatives.

The chancellor said the figures showed the government had “more to do” to support households. “I know families are still struggling with the cost of living and today’s figures are a reminder that for too long the economy has not worked for working people.

“I am fighting to put more money in the pockets of working people. That’s why at the budget we protected their payslips with no rise in their national insurance, income tax or VAT, boosted the national living wage by £1,400 and froze fuel duty.”

Business leaders have warned the decision will hit jobs and force employers to pass on the higher costs by raising prices.

The Bank cut interest rates for a second time in November despite warning that Reeves’s budget would add to near-term inflationary pressures while boosting growth in the economy.

Threadneedle Street raised borrowing costs from a record low of 0.1% in December 2021 to as high as 5.25% in response to soaring inflation. Although the headline rate of inflation is expected to remain above 2% throughout next year, City economists anticipate further interest rate cuts to as low as 4% by the end of 2025.

Source: TheGuardian

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JPMorgan

Economic

Many years ago, I worked for the Office of Revenue and Tax Analysis at the State of Michigan and, from time to time, Saul Hymans and his colleagues from the University of Michigan would visit the state government in Lansing to discuss the latest output from their macro economic models of the U.S. and Michigan economies.

As they started into their presentation, I was always eager to hear about their forecast. However, I was rather puzzled about how much time they devoted to the current quarter. I mean they had a big macroeconomic forecasting model – couldn’t we just skip the present and move on to the future?

Over the years, however, I came to appreciate their process. Forecasting is extremely difficult and projections can fall off the rails pretty quickly. That being the case, you should, at a minimum, be pretty clear on initial conditions.

This seems particularly relevant today. At first glance, the economy appears to be on a stable, non-inflationary growth path. However, many financial assets have vaulted off the springboard of that foundation to reach very high valuations. Moreover, the outlook for the economy in 2025 could be significantly impacted by policy changes from the incoming administration, while some longer-term risks are growing. Meanwhile, many investors have much larger, but less balanced, portfolios than just a few years ago.

All of this suggests that most investors should consider some adjustments entering 2025. But in deciding precisely what to do, it is first important to understand initial conditions, as we exit 2024.

Growth

Starting with economic growth, following annualized gains of 3.0% and 2.8% in the second and third quarters, respectively, real GDP is on track for a roughly 2.5% gain in the fourth. Digging into the details, consumer spending appears to climbing by between 2.5% and 3.0%, led by a surge in light-vehicle sales to their strongest pace in three and half years. The Boeing strike likely depressed business fixed investment after three consecutive quarters of 4%+ real growth. However, with this strike now resolved, aircraft output should rebound in early 2025. Homebuilding remains depressed due to much higher mortgage rates than a few years ago. However, from these depths, housing starts should slowly increase, reflecting very low inventories of homes either to buy or to rent. Government spending remains on a steady upward path, as state and local government employment continues to expand, following a delayed post-pandemic recovery. Meanwhile, both inventory growth and the trade deficit should fall in the fourth quarter, following a third-quarter surge in imports and stockpiling.

Importantly, we estimate that this pace of GDP growth in the fourth quarter, combined with Friday’s employment report, implies a 1.9% year-over-year gain in productivity in the non-farm business sector and a 2.6% year-over-year increase in real GDP per worker. These very solid productivity gains should allow the economy to meet steadily growing aggregate demand with steadily growing supply without generating higher inflation, provided the economy can produce further moderate job gains and avoid major exogenous shocks to prices.

Jobs

On employment, the frustrating highlight of the November jobs report was measurement issues, with the establishment survey reporting a strong 227,000 increase in non-farm jobs in sharp contrast to the household survey, which showed a dismal 355,000 slide in the number of workers. However, as we have argued before, the best way to assess the labor market is by looking at a broad mosaic of data. This includes government surveys of businesses and households, private sector surveys, unemployment claims, demand growth that drives gains in jobs and consumer spending that results from those gains. Looking at these in turn:

The payroll survey shows average job gains of 171,000 over the past three months and 190,000 over the past year, although initial estimates of re-benchmarking adjustments suggest that this overstates job growth.

The household survey shows an average decline in the number of workers of 98,000 over the past three months and 62,000 over the past year. However, this is based on an estimate of just a 0.6% increase in the 16 and older, civilian, non-institutional population, which, given the immigration surge, is probably an underestimate.

Both initial and continuing unemployment claims have stabilized in recent weeks at levels that are below their averages for the five years before the pandemic.

The Conference Board consumer confidence survey shows twice as many people claiming jobs are “plentiful” as opposed to “hard to get” while the ISM manufacturing and non-manufacturing surveys suggest roughly stable job growth in November. The National Federation of Independent Business monthly job survey shows still elevated job openings relative to history, mirroring government data. In all cases, these data suggest less labor market tightness than in the super-hot market of 2022. However, they all also suggest recent stabilization in the job market at strong levels.

Finally, steady real GDP gains of between 2.5% and 3.0% over the past 9 months suggest solid job growth into 2025 while early indications on fourth-quarter consumer spending provide circumstantial evidence that the labor market is still improving.

Inflation

This week will see the usual mid-month crop of inflation data, with consumer prices due out on Wednesday, producer prices released on Thursday and import prices published on Friday. We expect a modest 0.2% month-to-month increase in both consumer and producer prices and an outright decline in import prices. All three of these measures could see higher year-over-year increases than a month ago, which some may point to as a sign that inflation is rising again. However, these stronger year-over-year gains are more of a reflection of cool inflation a year ago than any genuine reheating in price pressures today. Indeed, it is important to acknowledge that there is very little evidence that inflation pressures are building.

First, there is little reason to worry about imported inflation, with mediocre overseas economic growth, rising non-OPEC oil production and a 7% increase in the trade-weighted dollar since the start of the year.

Second, we estimate that fourth-quarter year-over-year wage growth will come in at 4.0% which, given an expected 1.9% year-over-year gain in non-farm business productivity, is entirely compatible with the Fed’s 2% inflation goal.

Shelter costs and auto insurance continue to play an outsize role in CPI inflation, accounting for 86% of the year-over-year increase in October. However, with inflation in new leases running well below the government’s measure of shelter inflation and new vehicle prices down year-over-year, both of these sources of inflation are likely to continue to abate in the months ahead.

Inflation expectations also appear well anchored, with the spread between nominal 10-year Treasuries and 10-year TIPs running at 2.24% on Friday, right in line with the CPI reading necessary to achieve the Fed’s 2% target for consumption deflator inflation.

In short, while higher tariffs and tighter immigration could result in higher inflation in 2025, this would be because of active policy choices rather than any underlying trend of rising inflation pressures.

Profits

On profits, in the first three quarters of this year, S&P500 earnings were up 5.7% on a pro-forma basis and 8.0% on an operating basis. As the year draws to a close, analysts are, if anything, getting even more optimistic, projecting year-over-year gains of 11.6%, pro-forma, and 13.8%, operating. Moreover, earnings growth appears to be broadening out - 10 out of 11 S&P500 sectors could post year-over-year gains in operating EPS in the fourth quarter of 2024, compared to just 5 a year ago.

Given this backdrop, and without the disruption of fiscal policy changes, the Fed should have been on track to ease slowly, in line with their September summary of economic projections, lowering the federal funds rate to under 3.00% by the summer of 2026.

Policy Risks and Portfolio Balance

However, despite these very benign initial conditions, investors have reason for caution as 2024 draws to a close.

First, the fine balance that the economy has achieved between growth and inflation could be upset by policy moves, with the potential for higher inflation, in 2025, due to tariff increases and reduced immigration and, in 2026, due to fiscal stimulus. Productivity gains from deregulation and fiscal drag from government cost-cutting would likely only partly counter these effects. Moreover, faced with the prospect of inflationary policy measures from the other side of Washington, the Fed could curtail its easing, as the futures market now anticipates. While we still expect the Fed to cut the federal funds rate by 25 basis points next week, in recognition of a benign inflationary starting point, its new summary of economic projections is likely to project less easing going forward.

Second, investors need to take a hard look at valuations. As the S&P500 hit a new all-time high on Friday, its forward P/E ratio climbed to 22.4 times, about 1.7 standard deviations above its 30-year average, with valuations looking even more stretched among large-cap growth stocks. Fixed income also looks expensive. The 10-year Treasury yield at 4.17%, is roughly 1% higher than year-over-year core CPI inflation, compared to an average 2.7% real yield in the 50 years before the Great Financial Crisis, despite massive and growing government borrowing. Meanwhile, credit spreads remain very tight for both high-yield and investment grade corporate bonds.

And, third, because of spectacular investment gains, many investor portfolios are now unbalanced. In particular, assuming no rebalancing and the reinvestment of income, a 60/40 portfolio at the start of 2019 would have more than doubled in value by today. However, that investment would now not be a 60/40 portfolio, but rather a 79/21 portfolio.

While most investors have likely rebalanced to some extent in recent years, many now have portfolios that are riskier than they were a few years ago even as the increase in their wealth could have allowed them to take less risk.

Despite general discontent that was so evident in the recent election, at the end of 2024, economic fundamentals remain very positive, particularly for financial assets. However, it is possible that policy changes or other events will undermine those fundamentals in 2025 – a risk that is amplified in portfolios by high valuations and portfolio drift. Given this, it is important for investors to ask whether the asset allocation that served them so well in 2024, is still right as we enter 2025.

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Warren Takunda

Economic

The Pound to Euro (GBP/EUR) showed a small yet clear decline after the ONS reported that UK headline CPI inflation rose to 2.6% year-on-year in November from 2.3% in October.

The increase confirms inflation is more likely to hit 3.0% before the Bank of England's 2.0% target.

However, it met market expectations, and for foreign exchange markets, expectations count. The Pound to Dollar (GBP/USD) eased to 1.2705, suggesting maybe the market was prepared for another upside surprise in the data, as was the case on Tuesday when UK wages caused some ripples in FX markets.

Also weighing on Pound Sterling was news that the CPI services rate was unchanged at 5.0%, which is lower than the market expected (5.1%).

Services inflation is where the most robust price pressures lie, and economists say this will ensure core inflation remains elevated and, in turn, headline CPI inflation.

For the Bank of England, services inflation must cool if it is to win the war on inflation. At 5.0%, it is still simply too high to warrant anything other than a cautious approach to lowering interest rates.

Indeed, the 5.0% reading is still higher than the Bank of England set out in its most recent forecast round (4.9%).

Pound Sterling Upside Still Favoured After UK Inflation Heads in the "Wrong Direction"_1

Above: Headline inflation is being held aloft by stubborn services inflation.

"These rates are well above those consistent with the 2.0% target and are currently moving in the wrong direction," says Paul Dales, Chief UK Economist at Capital Economics.

To be sure, the GBP's reaction to these data is relatively muted, which is expected when considering the broader message: inflation is rising again, and the Bank of England must remain vigilant.

This will bolster the view that the Bank won't cut rates on Thursday and will likely maintain a message that it will remain cautious.

It will reference an ongoing slowdown in the UK labour market and economy, throwing up some 'dovish' tinges to proceedings, potentially weighing on the Pound.

But policy setters are boxed in by still-high services inflation, which might only rise further as UK wage pressures remain elevated. There is a transmission from higher wages to strong demand to increases in the prices charged by services businesses to customers.

"Even though activity has been weaker than the Bank expected, the stronger-than-expected rebounds in wage growth and CPI inflation published yesterday and today mean that the Bank won’t be able to worry less about inflation for a while yet," says Dales.

Recent data and Thursday's Bank of England outcome are unlikely to alter current FX trends that broadly favour GBP upside against European currencies and commodity currencies (AUD, CAD, NZD).

Source: Poundsterlinglive

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ACY

Forex

Economic

The USD: A Symbol of Strength in Uncertain Times

The US Dollar, has proven to be a steadfast performer, maintaining its dominance in the global currency markets. As the Federal Reserve prepares for its final policy decision of the year, the USD has been trading near a critical resistance level of 107.00 on the dollar index. Why the USD is Soaring While the JPY Falters_1

Why the USD is Soaring While the JPY Falters_1

Federal Reserve Policy Expectations

The Federal Reserve's approach to monetary policy has been pivotal in driving the dollar's performance. While inflation in the US has shown signs of moderation, the Fed’s cautious stance on future rate cuts continues to lend support to the currency. Investors are closely watching the Fed's upcoming policy meeting for signals on the direction of interest rates in 2025. A pause in rate hikes would reflect confidence in the economy’s stability, while any hint of further tightening could reinforce the dollar's bullish momentum.

Yield Differentials

Yield spreads between US Treasury bonds and the debt instruments of other major economies remain a significant factor underpinning the USD’s strength. The relatively higher yields on US assets attract global capital, especially as other central banks, such as the Bank of Japan and the People’s Bank of China, adopt more accommodative policies.

Why the USD is Soaring While the JPY Falters_2

Global Economic Headwinds

The USD continues to serve as a haven amid global economic uncertainties. China’s slowing economic growth and its potential rate cuts have widened the yield gap with the US, further enhancing the dollar’s attractiveness. Additionally, geopolitical tensions and trade uncertainties provide a steady tailwind for the USD, as investors flock to the perceived stability of the American economy.

The JPY: Struggling Under Pressure

On the other side of the spectrum, the Japanese Yen finds itself in a precarious position. Once regarded as a haven currency, the yen has faced a steady decline in 2024, trading above the 154.00 level against the dollar. This weakness reflects a combination of domestic policy challenges and external market forces:

The Bank of Japan’s Ultra-Loose Policy

The Bank of Japan’s reluctance to raise interest rates has been a defining feature of the yen's underperformance. Despite rising inflationary pressures, the BoJ remains committed to its ultra-loose monetary policy, emphasizing the need for stable and sustainable growth before considering significant changes. Market participants now anticipate no rate hikes until early 2025, a stance that contrasts sharply with the more aggressive tightening cycles of other central banks.

Investor Sentiment and Policy Credibility

The BoJ’s communication strategy has further complicated the yen’s outlook. Following unexpected policy adjustments earlier in the year that triggered financial instability, the central bank has adopted a cautious tone to avoid further market disruptions. However, this has led to scepticism among investors, prompting increased yen selling in December as market participants adjust their expectations.

Yield Gaps and Global Dynamics

Japan’s persistently low yields make the yen less attractive compared to higher-yielding currencies like the USD. The stark divergence in monetary policy between Japan and the US has widened the yield gap, exacerbating downward pressure on the yen.

USD vs. JPY: The Tale of Two Economies

The contrasting paths of the USD and JPY underscore broader narratives about the US and Japanese economies. The US has shown remarkable resilience, supported by robust consumer spending, steady job growth, and strong corporate performance. In contrast, Japan faces structural challenges, including a rapidly aging population, stagnant wage growth, and a heavy reliance on external demand.

As China’s economic slowdown impacts global trade, Japan’s export-dependent economy is particularly vulnerable. While the BoJ aims to stimulate domestic demand through accommodative policies, these measures have yet to translate into significant economic gains.

Why the USD is Soaring While the JPY Falters_3

Implications for Traders and Investors

For currency traders and investors, the divergence between the USD and JPY presents both opportunities and risks:

For USD Bulls:

The dollar’s upward trajectory is supported by a strong economic backdrop and favourable yield dynamics. However, caution is warranted as any dovish signals from the Fed could temper its gains.

For JPY Bears:

The yen’s continued weakness seems likely in the near term, particularly if the BoJ maintains its current policy stance. However, any unexpected shifts in Japan’s monetary policy or global risk sentiment could trigger sharp reversals.

What Lies Ahead?

As 2024 draws to a close, the interplay between the USD and JPY will remain a focal point for global markets. The Federal Reserve’s final policy announcement of the year could set the tone for the dollar’s performance in 2025, while the Bank of Japan’s cautious approach leaves the yen vulnerable to further depreciation.

Ultimately, the USD’s strength and the JPY’s weakness reflect deeper economic and policy dynamics. For investors, staying attuned to central bank decisions, macroeconomic data, and global risk sentiment will be essential in navigating this complex and evolving landscape.

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Warren Takunda

Economic

Moody’s cut the ratings of seven French banks just days after downgrading France’s credit score, as the country grapples with prolonged political instability. The move caused a broad-based fall in French big banks’ stocks, with BNP Paribas down 0.97%, and Credit Agricole falling 0.84%. The Euro Stoxx banking sector slumped 1.49% on Tuesday, making it the biggest laggard in the pan-euro Stoxx 600 index.

The credit downgrade followed the ousting of Michel Barnier over the 2025 budget proposal, which faced rejection from both the far-right National Rally and the left-wing alliance. The rating firm stated: “France’s public finances will be substantially weakened over the coming years, because political fragmentation is more likely to impede meaningful fiscal consolidation,” and “there is now very low probability that the next government will sustainably reduce the size of fiscal deficits beyond next year.”

France’s government debts reach a record high

France’s deficit level climbs to 6.1% of its Gross Domestic Product (GDP) in 2024, more than double the European Union’s threshold of 3%. The country’s debt hit a record of €3.228 trillion, or 112% of the GDP, which is the third highest ratio in the eurozone, after Greece and Italy.

Barnier’s budget plan, which aimed to lower the deficit to 5% in 2025, was met with fierce opposition by the far-right National Rally and the left-wing alliance. On Monday, the French National Assembly approved a special law to temporarily avoid a US-style government shutdown by allowing tax-raising and government spending to roll over. However, the absence of a full 2024 budget plan leaves newly appointed Prime Minister François Bayrou facing the same challenges that ousted his predecessor.

In May, S&P Global Ratings downgraded France’s credit score from AA to AA-, forecasting a deficit level of 3% of GDP until 2027. On Saturday, Moody’s ratings agency downgraded France’s credit score to Aa3 from aa2. Fitch has also cut France’s government bond ratings previously.

Selloffs in French government bonds and stocks

Both French government bonds and stock markets experienced selloffs amid the ongoing political upheaval. The CAC 40 is a rare underperformer with a negative performance this year, in stark contrast to global benchmarks. Year-to-date, the index is down 2.35%, while the euro Stoxx 600 index is up 7% and the DAX rallied 21%. Wall Street repeatedly reached new highs, with the S&P 500 recording a 27% growth and the Nasdaq surging by 34% this year.

The credit downgrades drove yields on French government bonds sharply higher, reflecting increased borrowing costs. The yield on France’s 10-year bond rose to 3.06%—the highest level in nearly a month—before pulling back. Bond yields move inversely to prices and represent investor confidence in a government’s ability to manage its debt. The heightened political uncertainty has significantly raised the risk premium on French bonds, exacerbating the selloff.

French banks bore the brunt of the political turmoil as investor concerns grew over the security of public finance. A potential government debt default could trigger a banking crisis across Europe, echoing a Greece-style crisis in late 2009. In late November, the French benchmark bond yield marched Greece’s for the first time in history, underscoring mounting fears of a government collapse.

Source: Euronews

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ING

Commodity

Economic

Energy – API reports oil inventory draws

NYMEX WTI is trading above $70/bbl while ICE Brent edged above $73/bbl this morning as a recent report from API suggests a sizeable drawdown in US commercial crude oil inventories. The continued threats of additional sanctions on Iran and Russian oil supplies along with persistent tensions in the Middle East and Europe continued to provide a floor for oil prices.

API numbers released overnight were constructive for the oil market. The institute reported that US crude oil inventories dropped by 4.7m barrels over the last week, compared to the market expectations of a draw of 1.6m barrels. On the other hand, API reported large inventory builds for products, with gasoline and distillate stocks increasing by 2.4m barrels and 0.7m barrels respectively. The more widely followed Energy Information Administration (EIA) report will be released later today.

The latest trade numbers from Chinese Customs show that imports of liquefied natural gas in the country fell 8.7% year-on-year to 6.2mt in November. This is the biggest drop reported since January 2023. The decline was largely driven by higher prices eventually hurting spot purchases. However, gas imports via pipeline have increased, with the majority coming from Russia.

As for gasoline, trade data shows that Chinese exports rose 42% YoY to 1.26mt last month, the highest monthly shipments since August 2023. A sudden jump in shipments could be mainly attributed to the plants rushing to ship before the reduction of a tax rebate from 13% to 9%.

Meanwhile, European gas prices reported their biggest intra-day gain in a month following the comments from the European Union that it has no interest in continued gas flows from Russia via Ukraine. TTF front-month futures rose over 4% to close above EUR42/MWh as of yesterday as the EU reaffirmed that it is prepared for the expiry of the transit deal between Ukraine and Russia by year-end. In the US, Henry Hub prices made a strong recovery yesterday, with front-month contract increasing around 10% from the lower levels as weather forecasts moderated slightly while prospects of European LNG demand improved for the coming months.

Metals – Iron ore falls on demand woes

Iron ore edged lower for a second straight session, with SGX prices falling below US$103/t in the early trading session today. The recent announcement from China for greater fiscal and monetary support next year failed to lift sentiment as the market continues to focus on the struggling property market and signs of a weakening steel industry in China.

Iron ore has been one of the worst-performing commodities so far this year, as the outlook from the Chinese downstream industry continues to deteriorate. Meanwhile, the latest estimates from Mysteel show that both crude steel production and apparent consumption in China are expected to decline in 2025. The group forecasts that China’s total crude steel output will fall by 1.3% YoY (around 13mt) to 990mt next year, as domestic steelmakers would be forced to curb output due to intensifying anti-dumping measures and tariff hikes targeting Chinese steel products.

The latest batch of trade numbers from Chinese Customs shows that imports of unwrought aluminium and aluminium products fell 17.6% YoY to 280kt in November, while cumulative shipments increased 26% to 3.45mt in the first 11 months of 2024. For steel products, imports fell by almost 23% YoY to 470kt last month, while cumulative imports fell 11.3% YoY to stand at 6.2mt in January-November this year. Looking at the exports, the country’s alumina exports jumped 56.7% YoY to 190kt in November, and year-to-date shipments increased 42.5% YoY to 1.6mt in the first 11 months of the year.

The latest LME COTR report released yesterday shows that speculators reduced net long positions in copper by 2,739 lots for a second consecutive week to 59,307 lots for the week ending 13 December 2024. Similarly, net bullish bets for aluminium fell by 1,191 lots for the second week straight to 113,214 lots at the end of last week, the lowest since the week ending on 11 October 2024. In contrast, money managers increased net bullish bets for zinc by 4,540 lots for a third consecutive week to 37,206 lots (the highest since the week ending 25 October 2024) as of last Friday.

Agriculture – India’s sugar output declines

The latest data from the Indian Sugar Mills Association (ISMA) shows that Indian sugar production (excluding ethanol diversion) fell 17% YoY to 6.14mt for the season until 15 December. Meanwhile, sugar diversion towards ethanol is estimated to rise to 4mt for the year, compared with 2.15mt last year. The Association added that despite the late start, the number of operating factories and the corresponding crush rate is picking up at a faster rate.

The latest trade numbers from China Customs show that corn imports dropped significantly by 92% YoY for a seventh consecutive month to 300kt in November, while cumulative imports declined 40% YoY to 13.3mt in the first 11 months of the year. For wheat, monthly imports fell 90% YoY to 70kt last month, while cumulative imports declined 4% YoY to a total of 11.02mt between January and November this year. The decline is very much in line with the government's initiatives to reduce overseas grain imports this year primarily to support the domestic market.

Recent estimates from France’s agriculture ministry show that the domestic winter grain plantation for 2025 will reach 6.3m hectares due to better weather conditions, up 6.6% from last year but 1.9% below the five-year average. Similarly, the soft winter wheat harvest area is expected to increase by 9% YoY to 4.5m hectares for the above-mentioned period. However, it remains low compared to levels seen over the past 30 years.

Weekly data from the European Commission shows that soft-wheat exports for the 2024/25 season dropped to 10.5mt as of 15 December, down 31% YoY. Rising competition from Russia and a poor harvest in France have weighed on export volumes. Nigeria, the UK, and Morocco were the top destinations for these shipments. In contrast, EU corn imports increased by 10% YoY to 9.2mt mainly due to weaker domestic supply this season.

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