What does the Blue Tsunami mean for inflation?

The recent US elections have sent shockwaves through financial markets, with investors closely monitoring the potential impact on economic policy and the billions invested in AI infrastructure. However, Thierry Wizman, a global rates and FX strategist at Macquarie Group, believes that all signs point to disinflation.

Over the past half-year, capital costs have been on the rise, with sovereign debt and corporate bond yields increasing as hyperscalers invested heavily in debt for data center expansion. The Federal Reserve has raised interest rates, and the cost of insuring against hyperscaler defaults has surged. But if President Trump backs away from the Iran war, oil prices fall, or tariffs are rolled back, yields could decrease.

Wizman notes that most of the recent yield changes can be linked to inflation expectations, as investors adjust their views accordingly.

French sovereign yields have been particularly volatile, and while they present opportunities, they also carry risks. Investors should wait for clearer indications of the election's outcome and any potential debt sustainability plans before making significant moves. The high yields in France are attractive, but the focus should be on the broader economic factors determining long-term debt trajectories.

Hyperscalers are indeed competing with governments for cash, which could potentially crowd out Treasury bond issuances. The US Treasury is considering reducing the issuance of 20- and 30-year bonds to prevent this competition. The surge in data center construction by hyperscalers has contributed to the higher bond yields observed throughout the year.

Investor sentiment has been affected by the changing political landscape in the US, with state and local legislatures becoming more restrictive on data center construction. Prediction markets can provide insights into rates and foreign exchange movements, but liquidity remains a challenge for institutional investors. The uncertain nature of these markets makes it difficult to hedge effectively.

On the US Treasury front, the initial rally in yields following the Blue Tsunami may have been a reflection of expectations for lower inflation. Three potential scenarios could contribute to a disinflationary environment in the US: slowing data center construction, a potential rollback of tariffs, and a drop in oil prices. While the unemployment rate has slightly increased, the Federal Reserve remains focused on controlling inflation and inflation expectations rather than the labor market.

Looking ahead post-midterms, the Democratic agenda is expected to prioritize reducing living costs. While success may be challenging, market sentiment could remain optimistic if there is widespread belief in economic improvements, coupled with potential tariff reductions.