Recent increases in US long-term rates surprisingly little impacted by inflation expectations

Even with strong capex, US nonfinancial corporations are generating more cash than they are investing

Investor sentiment worldwide is positive, especially in AI-led Asia

Sectoral shift in US job openings

Meteoric rise in AI-related semiconductor exports fueling South Korea's export boom

Regional Fed surveys showing further manufacturing acceleration in August

Sharp drop in China demand for oil helping to limit impact of Middle East conflict on the price

Decades high real price of copper posing physical challenge to investment boom

Rising US long-term real yields point to strong demand for investment funding

US retail sales accelerate even as consumers remain gloomy

Retail gasoline price still well above pre-conflict level and now rising again

PMIs showing widespread revival of global economy

Crude oil price has returned to pre-conflict level but traffic through Hormuz still subpar

Surging orders for computers and electronics propelling durable goods orders

Next year's inflation forecasts are on the rise and above target

Disrupted global supply chains placing upward pressure on US goods prices

Construction of data centers has overtaken transportation construction in US

Elevated energy prices putting intense upward pressure on input prices around the globe

US is big leader in global surge in private AI investment

Larger-than-usual income tax refunds this year are supporting consumer spending

Sharply rising share of AI-related jobs

Inflationary impact of surge in oil prices larger in Europe than in the US

Futures market thinks the price of oil will recede significantly over the next six months

Recent pickup in US defense orders could help support overall growth ahead

Cost of transporting crude oil has soared to series high

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Sharmila Whelan

Korea is emerging from the extraordinary political turmoil of 2024–25, triggered by former President Yoon Suk Yeol’s declaration of martial law in December 2024 and subsequent impeachment. The Lee government has since consolidated its political position, winning 12 of 16 major mayoral and provincial contests in June. 

Political upheaval was not the only challenge. Last year was difficult for Korean exporters too, and external headwinds remain. Korean goods continue to face 15% US import duties, with tariffs on certain products rising by a further 10–12.5% in July 2026 under measures related to forced-labour policies. 

Yet Korea—and its exporters in particular—has bounced back. Riding the global semiconductor upcycle and successfully diversifying export markets, exporters have seen both volumes and pricing power rebound sharply. In August, export volumes rose at a double-digit rate for the ninth consecutive month, climbing 26% YoY, while export prices surged 40.7%. 


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Source: Haver Analytics & Westbourne Research 

Korean exporters are nimble. Production diversification is a game they have been playing for years, well before Trump’s 2025 global tariff war. Exploiting comparative advantages, particularly lower labour costs, Korean companies have expanded assembly operations and supply chains across Asia, increasing their resilience to global trade tensions. 

Vietnam and Thailand are good examples. Korean intermediate and capital goods feed into local production and processing, with Vietnam emerging as an important production base for semiconductors, electronics, rubber and plastics, basic metals and electrical equipment. 

Increasingly, however, these ASEAN hubs are gateways to final demand elsewhere. The share of Korean chip and electronics exports to Vietnam ultimately destined for the US rose from 12.8% in 2016 to 21% by 2022, while China's share increased by more than eight percentage points to 19.4%. Meanwhile, the share absorbed by ASEAN final demand has fallen. 


261002sw02.jpg

Korea has therefore pursued a two-pronged strategy: investing directly in major final markets, particularly the US, while continuing to use connector countries as production hubs. 

The strategy is working. Korean exporters continue to hold their own in major markets—in the US, riding the AI capex wave; in Europe, despite rising protectionism; and in China, despite cut-throat competition, rapid growth in indigenous Fourth Industrial Revolution technologies and weak consumer demand. 


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**Korea Inc.**

The corporate profit cycle is strengthening, and it is not just chip companies, although they lead the improvement. The cycle bottomed in 2022 but did not move into a firm upswing until 2024, when average returns and EBITDA margins of listed companies rose above their pre-Covid 2013–19 averages. Gross margins followed last year, with all three metrics continuing to improve in the first half of 2026. 

More importantly, companies are now putting those profits to work. Until last year, free-cash-flow yields remained high even as valuations rose, suggesting companies were generating cash but not reinvesting it. This year that has changed. 


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The investment cycle has troughed. Real gross fixed investment has turned positive after contracting from 2Q24 through 4Q25, led by increased spending on IT and semiconductor capacity and R&D. Facilities investment strengthened for a second quarter, rising 6.5% YoY. 

Construction remains the drag. Although the pace of contraction has eased, the sector is being squeezed by a weakening credit cycle, higher interest rates and property measures aimed at reining in prices and speculation. 

Even so, expect the investment cycle to swing upwards as IT-related capex gathers momentum and gross fixed investment begins to outpace economic growth. Leading indicators are supportive: inventory-to-shipment ratios have normalised, capacity utilisation and operating ratios have risen since May, manufacturers are the most optimistic in three months, and machinery demand for equipment investment is growing briskly. 


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The fortunes of Korea Inc.—large companies and the SMEs embedded in their supply chains—remain disproportionately tied to the global semiconductor cycle. For now, that cycle is driving investment higher. 

There are risks. US hyperscalers are starting to pace investment, concerns about AI's unintended consequences are growing, and China's lower-cost open-source models pose an increasingly credible competitive challenge. But demand continues to outpace supply, while greater competition is accelerating innovation and demand for AI hardware. 

There will be ups and downs. Korea's ability to weather a temporary slowdown rests on two things: market dominance and strong corporate balance sheets. 

On the first, Korea is formidable. Samsung Electronics and SK Hynix dominate some of the fastest-growing semiconductor segments. As of 2Q25, Korea accounted for 63% of the global DRAM market, 83% of HBM and 47.5% of NAND chip supply. 

**The Korean consumer** 
Employees of Fourth Industrial Revolution companies—notably Samsung Electronics and SK Hynix—are sharing in their employers' good fortune. Higher bonuses are translating into greater spending on leisure and culture, dining out, automobiles and high-value discretionary goods. 

Consumption in semiconductor-heavy regions is running almost 4% above less-exposed areas. The Bank of Korea estimates the marginal propensity to consume out of after-tax bonus payments at 27% in 2025 and 21% this year. The spillover is now large enough to be visible nationally, accounting for around 2% of last year's growth in private consumption. 


261002sw07.jpg

Great. But not so fast. 

First, the effect remains concentrated in Icheon, Hwaseong and Cheongju—the manufacturing hubs of Samsung Electronics and SK Hynix. Second, the BoK estimates the boost to 2027 GDP growth at just 0.06–0.09 percentage points. Third, semiconductors are not particularly labour intensive: the industry's employment-inducement coefficient is only 2.0 jobs for every KRW1bn of additional demand, compared with 4.9 for shipping and 4.3 for motor vehicles. Finally, overall consumption is also being supported by fuel-cost subsidies, EV purchase subsidies and stock-market wealth effects. 


261002sw08.jpg

Economy-wide wage growth is less encouraging. Average wages rose 2.2% YoY in the first half, down from 3.6% a year earlier and barely keeping pace with inflation. Consumer inflation subsequently accelerated to 3.1% YoY in August, while interest rates are rising and household credit growth is beginning to soften. 

The outlook is therefore for a modest, rather than spectacular, consumer recovery—although Korea's consumption story is still stronger than Japan's, where even robust nominal and real wage growth has failed to persuade households to spend. 

**Inflation and monetary policy** 

The BoK has tightened twice this year, most recently raising the policy rate by 25bp in August to 3%. Expect further hikes. Pipeline inflation remains significant, broad money growth is trending higher and the economy can absorb steeper borrowing costs: real lending rates have turned deeply negative. 


261002sw09.jpg

Where to invest? 

We remain overweight Korean equities, with a bias towards semiconductors, electronics, electrical equipment, capital-goods industrials, export cyclicals and banks, the latter benefiting from improving net interest margins. 


Korea (Republic of)

Korea Strikes Back 

Charles Steindel

The US Bureau of Economic Analysis (BEA) estimates that New Jersey’s real GDP grew at a 1.7% annual rate in the second quarter of 2026. This is .5 percentage points under that nation’s 2.2% rate of growth. That gap was the same as in the first quarter of the year, and in line with the longer-trend of New Jersey’s growth averaging slower than the nation by roughly that amount.

The second quarter was the fifth straight to see New Jersey’s economy growing more slowly than the nation’s (despite the longer-term trend, there are times—such as the first quarter of 2025—in which growth here has been higher). The state GDP estimate is built up from estimates of output by industry. A softer performance in manufacturing was the main source of the second quarter gap, while a poorer performance in finance was the major culprit for that in the first quarter.

The story was decidedly difference for personal income. New Jersey’s 5.8% growth rate (in current dollars) was one of the 10 highest in the nation and well above the nation’s 4.8%. New Jersey outstripped the nation in most types of income, most critically in the central “net earnings” (employee compensation plus the earnings of noncorporate businesses) category.

The divergence between New Jersey’s GDP and income showing has been evident for some time. Which set of numbers is more reliable? Estimates of industry output at the state level depend upon some fairly arbitrary assumptions, which raise concerns with state GDP figures, especially the quarterly ones. At least the largest component of state personal income—wages—is fairly well-measured, and the figures for transfer payments to persons are likely reasonably good. The implication is that we may put just a bit more stock in the quarterly income numbers seems to be in loose agreement with the fairly robust numbers the state has been reporting on tax collections.

BEA has also released one bit more state economic data: an estimate of 2025 spending by New Jersey consumers. According to BEA, spending by New Jersey households increased 4.8% (not adjusted for inflation) last year, compared to the national figures of 5.3%--a gap comparable to that we typically see for GDP. State estimates of consumer spending, though, are subject to some of the same concerns as those for state GDP, resting on fairly arbitrary assumptions on the allocation of the national figures across the country.

260930CS1.jpg

- GDP growth gap of .5 percentage points in line with long-term trend.

- Personal income performance one of the best in the nation.

- 2025 household spending trailed the nation.


Q2 New Jersey GDP Trails Nation, but Income was Stronger

Andrew Cates

_Artificial intelligence can lift productivity and sustain business investment. The scale and durability of the gains will depend on labour, energy, materials, finance and the policy response._

**Introduction and summary messages**
The surge in artificial-intelligence investment is being driven by the technology's potential to raise productivity and corporate profitability. It is unfolding, however, in a world economy increasingly constrained by scarce labour, power, materials and capital. Those constraints make labour-saving technology more valuable, but they also limit how quickly the infrastructure supporting it can expand.

The initial macroeconomic effects can be favourable. If productivity rises faster than wages, unit labour costs fall. Firms can expand output without increasing employment at the same rate, supporting margins while containing underlying inflation. Stronger supply can therefore coexist with resilient demand and give monetary policy more room to accommodate growth.

The central risk comes later. Capacity and scarcity determine whether that favourable chain continues or reverses. Productivity gains can be diluted if electricity, grids, equipment, industrial materials or skilled labour become binding constraints. Inflation may then rise even before demand has weakened, leaving central banks to balance price stability against the investment needed to expand supply.

**Backdrop**
Companies are buying computing power, software and equipment because they expect to produce more with fewer workers. Scarcity adds urgency to that calculation. Labour is expensive, trade is more fragmented and capital is no longer free. Governments are also investing in energy security, defence and domestic supply chains. Climate disruption and tighter immigration policies in some economies are adding to the pressure on energy systems, transport, construction and skilled labour.

Energy is where the tension is sharpest. Digital capital can be installed quickly; power stations, transmission lines and mines cannot. The most important price in the AI boom may therefore be the price of electricity rather than the price of a semiconductor.

The investment response is already visible. Orders for capital goods across the United States, Germany and Japan have risen for seventeen consecutive months, while Asian semiconductor exports tell the same story from the production side. Inflation-adjusted orders remain below their 2021 average, suggesting that the cycle is still relatively young.

The increase in investment is only the starting point. Its economic significance will depend on whether it produces measurable gains in output and productivity, how those gains are divided between labour and capital, and whether the expansion runs into physical or financial constraints. The framework below traces that transmission before the subsequent section considers what the available evidence suggests about how far it has progressed.

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Figure 1  G3 capital-goods upswings since 1992, aligned on the month when growth turned positive. The current cycle is shown in navy. Weights: United States 0.5, Germany 0.25 and Japan 0.25, on a volume basis.

**A framework for the transmission**
The framework below traces how a positive productivity shock can pass through an economy. Higher productivity affects unit labour costs, margins and returns on capital. Those outcomes shape inflation, investment and monetary policy, while the cost and availability of finance influence how quickly new capacity can be built. The favourable process continues while productivity gains expand effective supply faster than labour, energy and financing costs rise.

260930AC2.jpg

Figure 2  The transmission of a productivity shock. The initial effect can support stronger output, improved profitability and contained inflation at the same time. Capacity and scarcity determine whether that favourable process continues or reverses.

Capacity and scarcity determine where the chain goes next. Four routes matter. They may overlap, but each begins in a different place and has different implications for growth, inflation and policy.

Productivity disappointment. If realised productivity fails to justify the scale of investment, the expected supply gains do not materialise. Firms may then cut capital spending, growth slows and part of the earlier investment proves premature. This is the risk most specific to an AI-led expansion.

Labour and capacity constraint. If demand grows faster than productive capacity, wage growth can move above productivity growth. Unit labour costs and core inflation then rise as margins weaken. Central banks may shift policy in a more restrictive direction just as the supply-side benefits begin to disappoint.

Capital and commodity constraint. Productivity may remain strong, but scarce electricity, grid connections, equipment, metals, construction capacity or savings make the next unit of productive capacity more expensive. The economy can remain healthy, but the pace of investment slows and resource costs put upward pressure on inflation and real interest rates.

Policy overshoot and demand break. Central banks may respond to constraint-driven inflation by raising borrowing costs far enough to weaken investment and broader domestic demand. Capacity pressure then disappears because the economy has slowed, delaying the supply expansion that would otherwise have eased the original bottlenecks.

**Evidence**
The evidence on corporate profits is consistent with the favourable part of this transmission. Output is rising without employment increasing at the same pace, while wage growth has lately slowed across the United States, the euro area and the UK. Higher interest rates have also cooled wages and consumer demand, so technology cannot take all the credit. Even so, profit margins have remained strikingly resilient.

US companies are earning more profit from each unit of output than at any point in the past 75 years. This does not prove that productivity is responsible, but it shows that recent output gains have not required a proportionate increase in labour costs. Capital has so far captured more of the gains than labour.

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Figure 3  US profit per unit of output and the extent to which profit growth has exceeded the growth of corporate operating income overall.

The financing position is also supportive. US companies are funding most investment from cash flow rather than relying heavily on borrowing, while euro-area companies collectively continue to generate more cash than they spend. Internal finance can sustain investment even when money is expensive. It also leaves the expansion less exposed to refinancing pressure, although that advantage would fade if borrowing began to rise sharply.

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Figure 4  US business investment after allowing for internally generated funds, together with borrowing as a share of investment. The lower panel shows whether euro-area companies collectively provide funds to the rest of the economy or need to borrow from it.

The physical constraints are, however, increasingly visible. Electricity has become relatively expensive in the US regions with the largest concentrations of data centres. Copper, uranium and other inputs linked to electrification have strengthened. Climate policies are also bringing forward demand for grids, storage and transition metals before new capacity is ready, while tighter immigration policies are limiting the construction and engineering labour needed to build it.

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Figure 5  Commodity prices relative to their two-year ranges, with separate measures for inputs associated with AI and electrification. The regional comparison shows industrial electricity costs in US data-centre regions against Texas.

Policy is the final link. Higher interest rates cannot create electricity, copper or skilled labour, but central banks cannot ignore cost increases that spread into wages and broader prices. Historically, rising order backlogs and slower supplier deliveries have been followed by tighter policy. Those pressures are now increasing again in the United States and the euro area.

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Figure 6  The blue lines show pressure on productive capacity fifteen months earlier; the bars show subsequent central-bank tightening or easing. The shaded area applies the historical lag to capacity pressure already observed. It illustrates the policy risk rather than forecasting future rate decisions.

**What to watch**
The most useful indicators follow the transmission chain. Realised productivity and unit labour costs show whether the technology is delivering. Profit per unit of output and broader margins show whether firms are converting those gains into higher returns on capital. Commodity prices and electricity costs reveal whether scarcity is raising the cost of new capacity, while corporate borrowing and real interest rates show whether finance is becoming a constraint.

The clearest warning would be slowing productivity, accelerating unit labour costs and weaker margins alongside persistently restrictive monetary policy. A sharp rise in corporate borrowing would suggest that the expansion had begun to depend on credit rather than cash flow. A collapse in orders or investment after policy tightened would show that a demand break was already under way. Followed link by link, the US chain is currently intact at the front but showing more pressure at the back.

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Figure 7  Five US indicators, one for each step of the transmission chain, each standardised against its own history since 2012. Amber marks a link under strain and teal a benign one, with every row oriented in the same direction.

**Implications for growth and policy**
The effects extend well beyond the technology sector. Greater use of artificial intelligence requires additional power generation, grid capacity, cooling systems, electrical equipment and industrial metals. These industries form part of the same investment cycle. How quickly they expand will help determine whether AI raises economy-wide productivity or encounters a persistent physical bottleneck.

The policy implications are equally important. Monetary policy must distinguish between demand that is running ahead of capacity and investment that is expanding capacity. Central banks still need to prevent higher energy and material costs from feeding into wages and broader inflation. Fiscal and structural policies can help by improving grid connections, permitting, infrastructure, training and the predictability of energy policy.

The overall conclusion is conditional. The favourable phase can continue while productivity improves, unit labour costs remain contained and investment is largely financed from internal cash flow. The risks become more pronounced if productivity weakens at the same time as resource and financing costs rise. The durability of the boom will therefore depend not only on the capabilities of AI, but on how quickly the physical economy and public policy adapt around it.

**Sources: Haver Analytics; US Census Bureau; Destatis; Japan Cabinet Office; BLS; BEA; Federal Reserve; Dallas Fed; Eurostat; ONS; OECD; S&P Global.**

Viewpoints: March 2024

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