J.P. Morgan: Financing costs reshape the AI trade as cash flow determines market divergence

Why is financing pressure still rising after the pause in rate hikes?

The Federal Reserve, European Central Bank and Bank of Japan held steady this week, as expected; the Reserve Bank of New Zealand surprised markets by keeping rates unchanged. JPMorgan expects all four central banks to raise rates once more in December.
The bank expects the Fed to raise rates by 25 basis points in December and then hold them unchanged for the rest of 2027, but sees an elevated risk of another hike. Resilient growth, sticky inflation and energy shocks have driven markets to reprice policy rates, with financing costs in turn becoming an important driver of AI asset volatility.
JPMorgan believes current stress reflects differing financing costs across assets more than a systemic solvency crisis. Its gradual-tightening view would be challenged by a disorderly financing shock and a significant earnings downturn.

During the rate repricing, cyclical stocks underperformed technology stocks, and lower-rated credit was also markedly weaker than higher-rated debt. As of 28 October, US high-yield spreads for BB, B and CCC debt had widened by 13, 28 and 359 basis points respectively this year; the lower the rating, the more pronounced the financing pressure.
The AI trade has also diverged: platforms that can build infrastructure with internal funds are being treated differently from highly leveraged emerging cloud providers that need continuous financing. JPMorgan remains positive on AI demand but prefers companies with stronger earnings and cash-generation capabilities.
The bank believes cyclical stocks need resilient growth and employment, easing geopolitical tensions, lower oil prices and declining inflation to sustain a catch-up with technology stocks, allowing central banks to remain patient. For now, it sees a broadening of market leadership as an opportunity rather than its base case.

Microsoft's Azure results and guidance met JPMorgan's thresholds, capital spending efficiency improved, and the company reiterated that it can generate free cash flow. Oracle disclosed its final financing amount and reiterated the year in which capital spending would peak, easing the bank's concerns about financing AI infrastructure.
Alphabet and Amazon provide counterexamples: the former's search growth slowed and free cash flow was negative for two consecutive quarters; the latter's AWS growth was its fastest in five years, but free cash flow swung sharply negative and core retail growth also slowed. Strong cloud demand and growing cash consumption can occur at the same time.
JPMorgan remains optimistic about the long-term prospects for Korea's and Asia's AI supply chains but is cautious in the near term: rallies and renewed sell-offs have alternated in the Korean market, while foreign demand has weakened as terminal rate expectations have risen.

JPMorgan analysed monthly returns on the S&P 500 and US Treasury indices from 2000 through 2026 to date, finding that bonds provided diversification benefits relative to equities in only 53% of the observation periods.
The higher inflation is, the more common simultaneous declines in stocks and bonds become: when PCE inflation was below 1.5%, stocks and bonds fell together 10% of the time; above 4.5%, the frequency rose to 42%. The bank believes yields could fall if AI financing or earnings concerns trigger an equity correction, or if weaker employment drags on demand, giving developed-market government bonds hedging value.
A key condition for this view is avoiding a new supply shock. If escalating geopolitical tensions push oil prices and inflation sharply higher again, the risk of simultaneous pressure on stocks and bonds will increase.

JPMorgan estimates Brent crude's fair value at about 94 dollars per barrel, versus a market price of around 114 dollars cited in the report. The roughly 20-dollar difference mainly reflects geopolitical risk. The bank believes higher freight costs can explain differences in physical oil prices across regions but have difficulty explaining the premium on the Brent benchmark itself.
Brazil's presidential election result triggered a repricing of assets: the Ibovespa's valuation fell from 9.7 times on the Friday before the election to 8.2 times on Thursday. The bank believes the valuation could still fall to around 7 times, expects domestic cyclical stocks to underperform exporters benefiting from a weaker currency, and has downgraded its Brazilian currency and local-rate positions from overweight to neutral, preferring higher-quality corporate credit.