Monthly Views and Perspectives: Reality bites for governments and AI investors

AI investment risks, France’s fiscal pressures and the Federal Reserve’s interest rate outlook came into sharper focus in October. Concerns about returns on AI capital expenditure, fiscal sustainability and the Federal Reserve’s policy outlook tested market confidence. U.S. Treasury yields retreated from two-decade highs, while the dollar index strengthened by 2.5%. These developments sharpened the focus on financing resilience, earnings quality and diversification.

The adjustment need not end the AI investment cycle or trigger a broader euro-area debt stress. Rather, it highlights the importance of distinguishing durable businesses and credible fiscal policies from optimistic expectations. Diversification and income generation remain priorities as the AI-led rally pauses.

Are neocloud companies a risk to the AI investment cycle?

Neocloud companies have recently come under the spotlight. They rent out computing infrastructure to train and run AI models, often funding their capex to build data centers by borrowing. October’s volatility in their stocks and bonds shifted attention from demand growth to AI infrastructure financing and financing sustainability.

Two mismatches matter. Construction spending precedes service revenues, while customer contracts may expire or need to be renewed before project debt is repaid. Returns depend on renewal prices and utilization, while equipment costs are fixed today and future computing prices could fluctuate.

Higher borrowing costs, competition and uncertain equipment lifespans raise the hurdle for profitable expansion. Power shortages and construction delays can postpone cash generation further. Strong demand alone does not guarantee attractive returns.

These pressures do not imply a financing collapse across AI. Large hyperscalers have diversified earnings and cash flow generating capacity and stronger balance sheets. Partnerships between AI model companies, hyperscalers and equipment makers may support infrastructure development, but this does not eliminate credit risk.

AI adoption continues, but model developers need time to generate revenues. Enterprise customers increasingly require tangible benefits and productivity boost before committing additional investment, while security incidents are drawing risk officers into adoption decisions. Long-term prospects remain intact, but revenue expectations need greater discipline.

The outlook therefore favors greater differentiation, with attention shifting towards robust balance sheets and revenues extending beyond AI.

Could France’s fiscal problems trigger a euro-area debt crisis?

France’s October social unrest has once again brought France’s fiscal outlook into focus, highlighted the country’s fiscal vulnerability. Persistent structural deficits have pushed government bond yields higher.

France’s 10-year yield broke above 5% and its spread over Germany exceeded 150 basis points, the widest since January 2012. French equities also corrected, reflecting domestic vulnerabilities alongside global technology weakness and subdued luxury goods demand.

With France’s fiscal deficit near 5.5% of GDP, higher debt-servicing costs and weak growth complicate consolidation. Passing a credible 2027 budget is the immediate test. As the next presidential election is held in April 2027, the current government and candidates will need to placate to voters’ demand.

Banks and domestically focused businesses face greater exposure to funding costs and weaker confidence. Overseas earnings cushion internationally diversified companies, although global demand remains a risk.

The ECB could ease broader financing pressures, but targeted French bond support is less straightforward where fiscal fundamentals explain higher premiums. For now, this remains a France-focused adjustment, not a renewed euro-area crisis. Countries hardest hit in 2012 have improved their fiscal positions. Stabilization depends on credible budget progress; negotiations, ratings and liquidity remain sources of volatility.

What does the Federal Reserve outlook mean for interest rates?

The FOMC voted 10–2 to hold rates at 3.75%–4.00%. Both dissenters favored an increase, and markets retained an 85% probability of a December hike. The decision signaled a pause, not a change in direction for the rate-hike cycle.

The brief meeting statement upgraded economic activity from ‘solid’ to ‘strong’ while describing inflation as ‘elevated’. Chair Warsh nevertheless conveyed less urgency, citing tighter financial conditions, anchored inflation expectations and signs that monetary restraint was working. Upcoming employment and inflation data will guide the Federal Reserve interest rate outlook.

There are going to be some changes in the meeting set up starting next year. The Fed will retain eight annual meetings. In 2027, seven will allow rate decisions and one will address monetary policy strategy without a decision or updated projections; in 2028, six will set rates and two will address strategy. Fewer decision points could concentrate market volatility on ‘live’ meetings and require larger moves. This ‘forward silence’ approach may also bring changes to economic projections and the dot plot.

Markets read the Fed’s message as less hawkish. Two-year U.S. Treasury yields and the dollar fell, although the 10-year yield remained anchored at 5%. With further tightening partly priced in, yields could stay range-bound unless the policy outlook changes materially.

Resilient earnings across developed and emerging markets remain supportive for equities, alongside opportunities in fixed income. Quality, diversification and income remain central to portfolio construction.

What does this mean for investors?

We view the volatility in the AI tech related companies is part of the maturing of the AI investment cycle. We are moving from hype and excitement to a reality check of where the weaker links in the infrastructure chain will face more scrutiny. Hyperscalers are not completely immune, but they should show more resilience, especially in the corporate debt space.

For sovereign debt, the risk of spillover from France to other European countries are low for now. The fact that Moody’s maintained France’s credit rating also provided some much-needed breathing space. Stress in the future could prompt flows to markets with stronger public finances. In Europe, this would be Germany. The U.S. government bond market, despite high deficit and rising government debt, its market depth and liquidity could also act as a safe haven.

On the Federal Reserve, it is increasingly clear that the upcoming rate hike cycle will be measured. This reinforces our view that the risk of bond yields rising further, especially at the short end of the Treasury curve, is limited. Income generation with fixed income is looking attractive once again. 

Global economy

• The Fed held interest rates at 3.75%-4.00% at the October FOMC meeting, pausing after September’s 25 bps hike, in a 10-2 vote with both dissenters favoring another increase. Fed Chair Warsh noted that inflation remained elevated, while domestic spending, productivity and capital investment remained resilient. He reiterated that future policy decisions would depend on incoming data and provided no explicit guidance on the December meeting.
  (GTMA P. 25, 26)
• The ECB held its deposit rate at 2.5%, as expected, while signaling that a December hike is likely. The decision was unanimous, and broadly stable underlying inflation and subdued wage growth leave the Governing Council room to assess incoming data. Lagarde’s planned departure in February 2027 puts leadership succession in focus, with three executive board seats expected to become vacant next year, though policy continuity is considered likely.
  (GTMA P. 19, 20)
• China’s growth stabilized in 3Q26, with GDP up 4.5% year over year versus 4.3% in 2Q, supported by exports and technology-linked industries while domestic demand remained weak. September exports surged 36.3% year over year, but retail sales rose only 1.1% and fixed-asset investment fell 7.2% in the first nine months, underscoring the persistent K-shaped recovery and property-sector drag. Inflation remained uneven: PPI accelerated to 5.0%, while CPI was 0.9% and core CPI held at 1.0%. Growth remains within the government’s 4.5%–5.0% target range, but a durable recovery will likely require stronger fiscal and monetary support to revive domestic demand.
  (GTMA P. 4, 5, 6, 7, 8)
• The Bank of Japan (BoJ) held its policy rate at 1.25%, as expected, with an 8–1 vote after Takata dissented in favor of a hike. The Outlook Report emphasized that underlying inflation has reached the 2% target, reinforcing the tightening stance, while projections and guidance changed little. Governor Ueda said future rate decisions would be made meeting by meeting. The BoJ will accelerate ETF sales from January 2027, but market reaction was muted given its effort to limit disruption. The baseline is for 25-basis-point hikes in December 2026 and March 2027, taking the rate to 1.75%, followed by a meeting-by-meeting approach.
  (GTMA P. 16, 20)

Equities

• Global and U.S. equities were mixed in October, with the S&P 500 declining for a second month and the Nasdaq lagging, while the equal-weight S&P 500 rallied as breadth improved. AI-related technology and communication services weakened on financing and capital-spending concerns, while energy, staples, utilities and health care led; resilient earnings and a Federal Reserve hold provided a counterweight.
  (GTMA P. 30, 31, 32)
• Asian equities fell sharply in October, with the MSCI Asia Pacific ex Japan index down 6.8% amid pronounced regional dispersion. Indonesia, South Korea and Taiwan lagged, while Australia and India gained as defensive shares and software services, respectively, provided support. Technology valuation and financing concerns, elevated oil prices and hawkish central-bank signals weighed on sentiment.
  (GTMA P. 30, 38, 42, 43)
• Greater China equities declined in October, with Hong Kong outperforming mainland markets as property shares and REITs cushioned losses in technology stocks. The CSI 300 fell 8.5% amid valuation, competition and capital-spending concerns. Strong industrial output and exports contrasted with weak retail sales and continued contraction in fixed-asset investment.
  (GTMA P. 30, 40, 41)
• Japanese equities fell in October, with the Nikkei down 5.2% versus a 3.5% decline in the broader Topix, reflecting heavier pressure on technology-linked shares. The Bank of Japan held rates steady, while above-target inflation and a weaker yen kept the policy outlook in focus.
  (GTMA P. 43, 44)

Fixed income

• The U.S. Treasury (UST) yield curve bull-flattened  in October, with 2-year yields falling to around 4.57%, while 30-year yields declined to around 5.29%. Yields eased amid softer labor market data, although elevated inflation and expectations for further monetary tightening continued to influence market expectations. Following the October FOMC meeting, markets continued to price the possibility of another hike in December, with the 10-year yield remaining close to 5% as investors awaited further inflation and employment data.
  (GTMA P. 56, 57, 61)
• Credit spreads widened in October amid growing investor concerns over heavy debt-funded AI investment and rising corporate leverage. U.S. investment grade spreads widened by around 10bps to 90bps, while U.S. high yield spreads widened more significantly by around 29bps to 340bps. Debt issued by AI infrastructure providers and neocloud firms also came under pressure amid concerns over aggressive borrowing and the sustainability of AI-related capital spending.
  (GTMA p. 64, 65, 66)

Alternatives

• According to PitchBook data, the number of global private equity deals in 3Q26 is estimated to have increased to 5,718, up from 5,613 in the last quarter. Deal value also rose to USD 499billion in 3Q26, from USD 463billion in the last quarter. Exit activity in global private equity also picked up, with USD 482billion across 1,089 exits estimated in 3Q26, up from USD 292billion across 996 exits in the previous quarter.
• As for the U.S. middle market, the J.P. Morgan Private Assets Index-Middle Market returned a total of -7.7% on a trailing 12-month basis as of September with revenue growth, net debt change and multiple expansion attributing to 9.8%, -2.4% and -13.9%, respectively.
  (GTMA P. 75, 76)
• Based on the KBRA DLD Direct Lending index on a par-weighted basis, the trailing 12-month default rate excluding non-accruals fell 10bps over the month to 2.2%, while the non-accrual rate remained unchanged at 1.8%. Consequently, the trailing 12-month default rate including non-accruals declined to 4.0%. Yield to maturity rose by 4 bps to 9.34% as of October.
  (GTMA P. 77, 78)

Other financial assets

• Oil prices rose in October amid persistent tensions in the Middle East and renewed concerns over supply disruptions. Brent crude gained 13.6% over the month, with the expiring December contract settling at around USD 118 per barrel, as escalating geopolitical tensions and threats to key energy infrastructure and shipping routes heightened supply risks. Despite ongoing geopolitical uncertainty, elevated U.S. yields and expectations for further Fed tightening continued to pressure gold, with prices declining to around USD 4,000 per troy ounce by end-October.
  (GTMA p. 72, 73, 74)
• The USD strengthened modestly in October, with the USD index (DXY) rising around 0.4% over the month as resilient U.S. economic activity and expectations for further Fed tightening supported the currency. Among other developed market currencies, the AUD and GBP strengthened against the USD, while the EUR weakened amid political and fiscal uncertainty in Europe. The Japanese yen weakened modestly to around 157.5 against the USD as investors assessed the timing of further Bank of Japan tightening, while the CNY strengthened to around 6.66 per USD, supported in part by continued exporter dollar conversions.
  (GTMA p. 69, 70, 71)

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