Anders Faergemann:

Welcome to the PineBridge Investments podcast, where we will be discussing AI productivity and the long-term ramifications for King Dollar. I'm Anders Faergemann, Head of Global Sovereigns and Economics. With me is Hani Redha, Head of Strategy and Research for Global Multi Asset. We've just wrapped up our monthly strategy meetings and there are some key insights to share. For example, Hani, you highlighted a significant productivity gap between the US and Europe, which has been developing since COVID. This strengthens the case for US exceptionalism, which is one of the main supporting factors for the stronger US dollar, which we've seen in recent years. This raises the question, is US exceptionalism becoming more structural in nature? And Hani, your thoughts on that?

Hani Redha:

Thanks, Anders, I assume you ask you know, other than being geeks who look at things like this, why would productivity be so interesting or useful? Well, look, productivity is absolutely critical in economic terms, in terms of both how an individual economy performs, but also across countries. It affects both the macro picture in terms of rates and is an important input into the level that interest rates will settle at, and in terms of currency markets, because the relative productivities are also a really key driver of FX crosses as well. So that's why we pay a lot of attention to it. And we happen to be, we think, in a productivity “Super-Cycle” right now. And so, there are times when it matters even more than other times.

And we are in one of those regimes where productivity is a primary driver that characterizes the entire regime and business cycle, and it's interesting to see how the data has been coming in and confirms this. As you said, the US exceptionalism theme is very well grounded in how productivity has evolved. We've seen the US diverge from the rest of the world in terms of how its productivity has been rising, even from before the pandemic, but it's accelerated since the pandemic.

And it's very interesting to us to see how that has come about, and how differently the US behaved during COVID, during the pandemic, that has contributed to this productivity out-performance. I mean, so for example, you know US firms benefited from a lot of fiscal support, as did firms around many other countries as governments came to their support during the pandemic crisis, and yet US firms used that capital, that support, to invest and to use technology to enhance their efficiency and their productivity and overcome a lot of labor shortages that a lot of firms were facing, and that's now starting to really pay off through the productivity gains that you would expect to see when technology has been deployed for some time.

And then on the labor side, it's also interesting to see how people in the US went “back to school”, they went and re-skilled themselves and re-tooled themselves, and they came back to the labor market, but they went into higher productivity jobs, and that rotation to higher productivity jobs has also contributed to productivity outperformance in the US relative to the rest of the world. So, I would say these are very strong reasons to expect this exceptionalism to be established and quite structural in nature.

Anders Faergemann:

Fantastic and I like your way of referring to going “back to school”. As you say, the labor force has been re-skilled, but now we have this new feature of AI. So how do the developments around AI impact the forward-looking prospects for productivity?

Hani Redha:

Yeah, excellent point. So, AI has really not been a contributor to productivity so far. So, everything I just described and everything that we see in the data so far has been even before AI makes its mark, and that's quite exciting to us, because it just means that there's even more potential going forward.

This is not a backward-looking phenomenon where we had this boost to productivity that's going to fade. There may be some cyclicality to it, yes, but when we look ahead, we see good reasons to expect productivity to continue to improve. And for now, we'd say the US is far in the lead when it comes to developing and deploying AI solutions.

The firms in the US just generally tend to be the first to pick up these opportunities and run with them, even when they're available globally, it tends to be US firms, US management that seizes that opportunity more than we see elsewhere.

Up to now, the build out in AI has been in what we refer to as Phase 1, which is the infrastructure build-out and so very significant, hundreds of billions of dollars have been invested in data centers and acquiring these very specialized semiconductors to build these AI models. And that was the first phase, and the US has really led that.

We're now seeing a transition to Phase 2, and it's being brought about by, you know the story, I'm sure many have heard by now around the DeepSeek model that was developed in China. And there are some doubts about whether this means we don't need to invest so much in expensive hardware, like they've done in the US, but we would say that's a very short-sighted way of looking at things.

Ultimately, firms are going to want to put the best hardware to work with the best models to maximize the productivity gains that they can squeeze out. And so, we think that, you know, CapEx is going to continue, and the US will continue to lead. That said, what DeepSeek has now done has revealed ways in which AI now becomes cheaper and more broadly available. It's faster and it's cheaper. It's going to democratize the availability of AI, which means faster adoption at the global level.

We would say the US is still going to lead its adoption, but it will be adopted faster elsewhere, and that means that a large range of additional applications of AI, things like what's being called “Agentic AI”, AI agents that actually can do things for you, rather than just answer questions are coming, and they're coming much faster. And all of this just continues to show us a very accelerated adoption of this general-purpose technology, this GPT, that AI is.

Anders Faergemann:

Fascinating stuff, Hani. So overall, what are the macro implications for rates and FX from all these insights about productivity and AI?

Hani Redha:

Sure Anders, yeah. I think you know, overall, this is one of the key pillars of the regime that we see ourselves in, which is characterized as “a higher nominal world”, higher growth, higher inflation, higher investment activity and as a result, higher interest rates as well. So, we think the resting heart rate of bond yields is higher than it was in the previous cycle. There's something that you and I and the team have debated very hotly over the years, but I think increasingly people have seen that we're not really going to go back to those ultra-low interest rates before. This is one contributor to that; productivity is one contributor to that higher equilibrium level of interest rates.

So that's one macro implication. The other is that if you believe that the US will continue to lead at least for some time, with regards to this new technology, it's supportive of a stronger dollar, all else equal. It means that the level of rates in the US will be higher than elsewhere. There will be less cutting needed in the face of stronger growth, but it's also disinflationary growth, and so it's something that also extends the life of the cycle, potentially. That's the other macro implication that I would leave you with, is that, without productivity, eventually inflation ends the party, but I think that productivity can give us more room to continue to expand the cycle without hitting those inflation limits.

Anders Faergemann:

Right. So we may end up needing to reevaluate the fair value for the US dollar, and maybe more specifically, versus the Euro?

Hani Redha:

Agreed. Now, I'd say that this is an important development that's happening. We've been very focused on it, because within equities, in multi asset, you know, we look across asset classes and within equities, this has been very top of mind and brings a helpful dimension to our macro thinking in our discussions on the fixed income side. But if we take a step back now Anders, why don't you round us out with an update on how things look “in all things-tariffs” and what are the conclusions we reached overall about how we should be positioning?

Anders Faergemann:

Sure Hani, tariffs are clearly top of mind, although we are seeing some market fatigue in reacting to headlines and tariff threats, so traders feel justified in waiting for actual implementation. Our take is that the market is getting slightly complacent here and the potential for escalation with Europe. So, there are risks coming into the next phase of tariffs around April 1st, both for Europe and China. Still, though these are “known-unknowns”, as we've talked about before, and unlikely to create significant volatility.

What we do know is that Trump's playbook has from the get-go, has been faster, more furious than during his first presidency. So, Trump's tactics seems to be going large, get some type of concession, then retrace and provide a new set of deadlines for negotiations. So, this feels almost like a boxer, you know, the one two and then retreat.

So, this escalate/de-escalate approach has worked so far in squaring off with Mexico, Colombia and Canada. He's then upped the ante with slapping tariffs on steel and aluminum, but that's similar to Trump 1.0 and now he's raising the stakes by announcing reciprocal tariffs on country-by-country basis.

So far, the market views this as an alternative to a universal tariff. And so the macro shock could be smaller than feared, especially if we leave aside VAT. And this is where it becomes more relevant for Europe. But it's ironic, Hani, how this comes across as a bit inefficient, so you can almost envision this boxer playing hundreds of online poker tables. Granted, he is the chip leader, but it's a lot of effort for very little gain, and so far, the market thinks of Trump as floating like a butterfly, biting like a mosquito.

But maybe to provide a bit of context to the strategy Treasury Secretary Scott Bessent confirmation hearing provided a glimpse into the Trump administration's policy goals, and it seems to be a three-pronged-attack on tariffs here – leverage, reshoring and finally, a revenue generator.

And if we focus on leverage for now, I believe Trump's treatment of Europe recently in the effort to get a permanent agreement on the Ukraine-Russia situation, served as a wakeup call to Europe, and it's policy makers and I do expect there's going to be a scramble in coming weeks to regain some influence, but this may affect their willingness to negotiate on trade and tariffs as well, and that's why I'm highlighting Europe as a potential risk, and the Euro is vulnerable in coming weeks.

At the end of all of this, we believe the end game constitutes higher tariffs on China, more sectoral tariffs on Europe, minimum on autos, maybe pharmaceuticals. And I know, Hani, you've been talking about, still potential as we can't rule out a universal tariff. So, I should say that these risks are embedded into our baseline scenario of a soft landing over 12 months and again, this is where we see lower yields ensuing eventually, as we've highlighted, there needs to be an inflection point from the inflationary impact from tariffs in the short term, but potentially that leads to financial conditions being more restrictive and weaker growth in the second half of the year. So, with that, we expect yields to stay high for now, but go lower over time.

Just to wrap up on what we've heard today, Hani, what I heard from you really underscores the validity of the argument for US exceptionalism, which obviously has contributed to US dollar strength in recent years. The AI technology investments are real and will underpin US growth, and indeed lead to an increase in the US economy's potential growth.

And altogether, this provides a strong case for US exceptionalism becoming more structural, again, continuing to underpin the US dollar and as I mentioned earlier, maybe a need to reevaluate the dollar's fair value, especially against the Euro. Thank you, Hani, for your insightful analysis. Thank you all for listening. We'll be back next month, and in the meantime, please visit pinebridge.com for more investment insights. Til next time, thanks for listening……”

ENDS