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Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.France is prepared to intensify public spending cuts and needs to pursue further structural reforms as it seeks to return to “sound public finances”, the country’s finance minister has said, as rising bond yields pile pressure on governments to bear down their deficits.Bruno Le Maire said he would try to wring out an extra €1bn in spending cuts on top of the €16bn announced last month in the country’s budget as it heads to parliament for review. This was “clear evidence” that Paris stood “ready to go further”, including by re-examining France’s generous welfare state.“If there is any possibility to go quicker in the reduction of public expenses and the reduction of public debt I will do it — I am totally aware of the risks linked to over-indebtedness,” Le Maire said in an interview in Marrakech at the IMF’s and World Bank’s annual meetings. “I also want to think about the French model: what is it in the French model that does not work? What is it which is too expensive and not efficient enough,” he added. “We need to address those questions.” Le Maire’s signalling comes as the government faces pressure from public finance and audit watchdogs and Brussels to defend its deficit-cutting plan, which is slower than many other EU countries. France will also soon begin another round of talks with credit rating agencies to defend its approach, including with S&P Global Ratings, which put it on negative outlook ahead of a review in December. Fitch has already downgraded France’s rating. France’s proposed budget for 2024 will lead to a deficit of 4.4 per cent of national output — well above the EU’s 3 per cent target — even though the EU is preparing to re-impose its debt and deficit rules after they were suspended during the pandemic. The government expects the deficit to fall below that level by 2027, making it one of the last EU countries to comply.The heavy borrowing comes amid a more febrile mood in global bond markets, as interest rates increase and investors question how quickly inflation will start dropping in the wake of central banks’ rate-rising campaigns.Investor worries in the euro area have focused on Italy, which was hit by a flurry of selling in bond markets last month after Prime Minister Giorgia Meloni’s government raised its fiscal deficit targets and cut growth forecasts for this year and next. Thousands of people protested against austerity and low salaries in Paris last week More

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Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.A top Federal Reserve official said it was “undeniable” that the slowdown in US inflation was a trend rather than a momentary blip, despite a recent string of economic data showing persistent pressure on some prices.Speaking to the Financial Times, Austan Goolsbee, president of the Chicago Fed, denied that progress was stalling on getting inflation back to the US central bank’s 2 per cent target. He cautioned against tying forthcoming monetary policy decisions to a narrow set of data.“There is a lot saying that inflation is trending down compared with what it has been and that’s what we want,” he said. “It’s undeniable this is a trend. It wasn’t a one-month blip . . . we have to hope and keep an eye out to make sure that continues.”The latest inflation report showed that consumer prices rose more than expected in September, to 3.7 per cent year on year. A surprising uptick in housing-related costs, as well as those related to hotel rooms and recreation services, kept core inflation, which strips out volatile food and energy prices, firm as well. The report followed an unexpectedly large jump in monthly payrolls. Together, the figures suggest that momentum in the world’s largest economy is still strong, intensifying the debate among Fed officials about whether they will need to raise their benchmark policy rate by one more quarter-point notch this year. The federal funds rate stands at a 22-year high of 5.25 per cent to 5.5 per cent, a level reached in July. Officials next meet at the end of the month.Goolsbee, who is a voting member on the Federal Open Market Committee this year, acknowledged that the reversal in rental and other housing inflation after months of easing was a “negative surprise” meriting a “proper element of caution”. Economists and policymakers had expected those prices to continue to moderate, given data showed a slowdown in most markets. Goolsbee said it was something he would closely monitor to determine the speed at which inflation fell from here.But he was much more sanguine about the jobs data, saying that large monthly gains while wage growth was slowing was most likely an indicator of improving labour supply rather than a cause for concern. In a recent interview with the FT, Treasury secretary Janet Yellen also subscribed to that view.“One of the worst things you can do is tie this monetary policy decision to what did the last data show the last month. You want to take a broader view,” said Goolsbee, who stressed he had yet to make up his mind about a November rate rise.However, he said, the Fed had been “rapidly approaching” a point where the policy debate was shifting away from how high to raise interest rates to how long they needed to be maintained at this level. Nothing in the data in the past six weeks had changed that. Since the last meeting in September, at which officials signalled support for one more rate rise this year and half a percentage point fewer cuts in 2024 than previously estimated, US borrowing costs have risen sharply. At one point, the benchmark 10-year Treasury yield was at its highest level since 2007. The rout has eased in recent days as policymakers at the Fed have hinted that tighter financial conditions may offset the need for another rate rise.Many, including hawkish governor Christopher Waller, have also reiterated that the central bank has the flexibility to maintain a more patient approach to future policy decisions, and can take time to assess incoming data to get a better grasp on the economy’s trajectory. This is something Goolsbee also endorsed.“That’s what I call the ‘data-dog’ approach. Let’s just keep sniffing,” he said. Complicating the two remaining decisions this year are external shocks, including a sharp escalation in tensions in the Middle East that has driven up oil prices and fanned significant uncertainty about the outlook for both global growth and inflation. An expanding autoworkers strike as well as the renewed spectre of a US government shutdown next month pose additional risks.Goolsbee, who maintained that the Fed could get inflation under control without substantial economic pain, said he was most concerned about disruptions such as these jeopardising that outcome. “Oil price shocks and external shocks have derailed soft landings that were easier than this one,” he said. More

This article is an on-site version of our Unhedged newsletter. Sign up here to get the newsletter sent straight to your inbox every weekdayGood morning. Earnings season has passed its first hurdle — big bank earnings on Friday were fine (though we are still waiting on Goldman and Bank of America, tomorrow). Next hurdle: big tech, starting with Tesla and Netflix on Wednesday. But observers of the US economy will find much to think about in some smaller companies this week: the trucker JB Hunt, the grocer Albertsons, Snap-on tools, assorted regional banks. Let us know what you are watching and why: [email protected] and [email protected] stocks as bond substitutes Sometimes I overthink things. Last week I wrote about my puzzlement about the extremely poor performance of consumer staples stocks since May. Flight to safety in reverse? Rate sensitivity of staples demand? Diet drugs cutting demand for cheap calories? None of the explanations, even in combination, seem quite satisfactory. Several readers wrote to point out I had missed an obvious candidate: staples stocks are a bond substitute, and as bond yields have risen to attractive levels, substitutes are no longer necessary. This is particularly compelling given that underperformance of staples began at about the same time that bonds began to offer positive real yields, and has continued as real yields have risen further.  This is more appealing than the other explanations. I think the reason that I didn’t think of it in the first place is that staples stocks have been expensive in recent years and, correspondingly, their dividend yields have not been particularly compelling. Back in May, when the staples sell-off began, yields for S&P 500 staples were about 2.5 per cent on average, only a bit better than the wider market. In the classic bond alternatives, utilities and real estate, yields were over 3 per cent and 4 per cent, respectively. What is a bond substitute, anyhow? It could be a source of yield — but also of safety, or diversification, or some combination thereof. The three are not the same.  In the horrible year 2022, when stocks and Treasuries were positively correlated and both fell hard, staples may not have provided much yield, but they provided safety. And as soon as the stock/bond correlation reversed in the spring of 2023 (with stocks rising and bonds falling) that ended:When real yields are significantly positive, there is less reason to own staples as a hedge against downward stock volatility. So if the era of zero or negative real Treasury yields are behind us, is the era of premium valuation for staples stocks over? Below are the price/earnings ratios of staples and the S&P over the past five years, which shows staples trading at a premium except in the rocket-like recovery of 2020-2021, when riskier, growthier stocks outperformed (a similar pattern emerged during the dot.com bubble). Those mid- and late-cycle staples premiums may be a thing of the past:Monetary tightening and the supply sideTight monetary policy hurts demand. What does it do to supply?Economists’ traditional answer: not much. The conventional view is that monetary policy is a tool of demand management across the business cycle, with few to no lasting effects on supply. From the vantage point of a monetary policymaker, supply is set exogenously, influenced by such uncontrollable inputs as regulations, taxes and productivity. The view, articulated by Milton Friedman half a century ago, boils down to “potential output is independent of monetary policy”, as the economist Olivier Blanchard wrote in 2018.One could look at this cycle and argue this seems about right. After a lag, historically fast monetary tightening is having its desired effect. Rising auto and credit card delinquencies weighing on sales for consumer staples are the most recent item in a list that includes depressed existing home sales, more corporate defaults and contracting profits. Meanwhile, supply has recovered from exogenous pandemic disruptions and appears largely unaffected by high rates. Official estimates of the US economy’s “potential” (ie, maximum sustainable GDP growth) suggest we will emerge from both the pandemic and the tightening cycle broadly unscathed:But the view that monetary policy is about demand management, with few implications for supply, is coming under question. Some economists are wondering if monetary policy’s supply-side effects have gotten ignored.In a paper presented at the Fed’s Jackson Hole conference in July, Yueran Ma and Kaspar Zimmermann argue that rate increases may hamper the supply side by reducing investment in innovation. This happens in two ways: through demand and through financing. By lowering end demand, tighter monetary policy makes it harder to find customers for new products, perhaps killing a project in the crib. And by raising the risk-free rate, tight policy reduces investors’ incentives to back riskier, cutting-edge products — the flip side of today’s popular “T-bill and chill” investment strategy.Innovation investment is hard to measure, so the authors look at everything they can, including nationwide investment in intellectual property products, early- and late-stage VC deals and public companies’ quarterly R&D spending. Most interestingly, they look at how monetary policy affects patent filings for technologies classified as disruptive, based on whether the underlying tech is a frequent mention in companies’ earnings calls. Across all measures, the authors find that less is spent on innovation investment in the years after a 100bp increase in rates. The decline is especially pronounced for VC funding, which declines as much as 25 per cent within three years. Patenting in disruptive tech falls up to 9 per cent.Ma and Zimmerman’s work points to one potential link between tightening and the supply side. By lowering innovation investment, long-term productivity drops, pushing output down. But does this idea match the empirical record? Another recent paper, published by three San Francisco Fed economists, looks at the relationship between tightening and long-run economic activity across the world since 1900. They find that tightening hurts growth over time by weighing on productivity and capital accumulation: The Fed economists argue this is best explained by rates throttling R&D investment and highlight a cruel asymmetry of monetary policy. While tightening depresses long-run GDP, monetary loosening has no corresponding benefit:If these findings are clear enough, what they mean for the Fed is less straightforward. Yes, VC funding and public corporation R&D spending has slowed this cycle. But taking this to mean the Fed ought to go easy on rates ignores institutional constraints. No other official actor is tasked with price stability like the central bank is. Preston Mui, an economist at Employ America who has written an excellent blog post summarising this literature, argues that targeted fiscal policy to support innovation investment is what’s needed. Happily, this appears to be happening. As private sector R&D investment has fallen, the state has made up for it, and then some:Mui points out that “a lot of the elevated government investment in R&D was Covid-related, such as health research expenditures, and then followed now by energy”. He expects the trend to continue as funds from the Chips Act and Inflation Reduction Act kick in. Perhaps one lesson is that for all the understandable hand-wringing about high deficits, big fiscal has big upsides, too. (Ethan Wu)One good readCorporate diplomacy at Microsoft.FT Unhedged podcastCan’t get enough of Unhedged? Listen to our new podcast, hosted by Ethan Wu and Katie Martin, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.Recommended newsletters for youSwamp Notes — Expert insight on the intersection of money and power in US politics. 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Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.The writer is a former chief investment strategist at Bridgewater AssociatesAs economies evolve, relationships between asset prices can change, often in such a quiet, evolutionary way that investors get caught off guard. That is what has happened with oil prices and the dollar. A change in the historical relationship is increasingly rippling through global economies and markets and putting emerging-market oil importers in a particularly unenviable spot.The “new” dollar-oil relationship goes back decades, the result of years of research and innovation in the US oil patch. New approaches to production, especially fracking and horizontal drilling, helped the US to transform from a large net importer to a net exporter of natural gas as of 2017. From 2019, it also has been net exporter of energy overall. It also became the world’s largest liquefied natural gas exporter last year.Being a net exporter of these critical commodities means that the dollar joins the “commodity currency” club. Today, in a way similar to dynamics seen in the Canadian dollar or Norwegian krone, rising oil prices improve the country’s terms of trade and provide a measure of currency support.Unlike its other club members, though, the dollar’s outsized role in global currency markets means that such strength creates large, often unwelcome global ripples. Specifically, today’s oil-dollar relationship means even greater pain for energy importers, especially in emerging economies. They face higher import costs while the strong dollar undermines their local currencies, increasing inflation and financial stability risks.The latest rally in crude oil prices, with Brent crude up more than 20 per cent since late June, came on the back of resilient demand but, perhaps more important, an increased sense that supply would stay constrained for the foreseeable future. On this front, Saudi Arabia led the charge, extending voluntary production cuts through the end of this year in an effort to support prices. The climb in oil prices was followed by appreciation of the dollar; indeed, the DXY index of the dollar against major currencies rose more than 6 per cent between mid-July and mid-October, according to Bloomberg.Of course, currencies are affected by a number of factors — trends in the terms of trade just one of them. In the dollar’s case, recent strength has also reflected the contribution from oil prices to fears that US inflation would fall more slowly than previously expected, in turn adding pressure on the Federal Reserve to keep interest rates higher for longer.You are seeing a snapshot of an interactive graphic. This is most likely due to being offline or JavaScript being disabled in your browser.This trifecta — higher energy prices, higher US interest rates and a stronger dollar — is the last thing many countries want to see right now. That’s particularly true for energy importers in Asia, where growth is already challenged by the drag emanating from a struggling China. South Korea, one of the world’s largest net oil importers, provides a good case study. In September, its consumer prices rose by the most in five months, lifted mainly by commodity prices. The central bank has kept policy interest rates steady. While hampering an already soft manufacturing sector, officials are more focused on bringing inflation down. That focus has included the currency: the central bank has been intervening regularly to prevent the won from weakening and raising import costs. Just last month, the won lost some 2 per cent against the dollar despite the central bank depleting reserves by roughly $4bn (1 per cent of total reserves), according to Bloomberg data.While investors should factor in the evolved structural dollar-oil relationship as they consider country exposures, it is also important to remember that oil-dollar correlations will still vary over shorter time periods, depending on what factors are dominating each asset. While today’s narrative is focused on oil supply, especially in the light of potential for a broader disruption in the Middle East, tomorrow the focus could easily switch to a decrease in demand if the delayed impact of tighter global monetary policy bites more.Ironically, falling oil prices, while they may hurt US terms of trade, may not be enough to sustainably, materially dent the dollar. What has also mattered historically is whether global investors see greater recession risks as reason to increase exposures to liquid US assets such as Treasuries. Such purchases have often helped support the dollar during economic downturns. That said, ongoing US government dysfunction and growing debt sustainability worries means we should watch out for another possible structural relationship change, this time between economic cycles and Treasury demand, with the dollar reflecting the outcome. More