French Bond Markets and AI Neoclouds Feel The Pressure

Sam Unsted · Bloomberg NewsBearish

EnScale is in a difficult position after valuation pushback and Microsoft's exit, with heavy customer concentration.

Sam describes EnScale, a UK-based data centre company trying to list in the US, as already facing valuation pushback that led to a difficult week or two. Microsoft then pulled out of a data centre project, which Sam believes is the largest in the country by overall value. He says this leaves EnScale in a difficult position because more than 80% of its revenue comes from just Microsoft and Anthropic. That makes it an extremely leveraged business.

“they've already had a bit of pushback on valuation, so they've had quite a difficult week or two... the vast majority, more than 80% of their revenue comes purely from Microsoft and Anthropic. And so, you know, they are extremely leveraged businesses.”at 20:23

Sam Unsted · Bloomberg News

Italian bonds are being dragged wider by France contagion even though Italy's politics have been stable.

Sam says investors are moving from France to weaker parts of the eurozone, including Italian government bonds (BTPs). Italy used to suffer sell-offs from frequent government changes, which Sam says no longer happens: Italy has been very politically stable over the past couple of years. He argues that Italian bonds are now being dragged along by the French concern spreading across the eurozone. John Stepek agrees that the spillover into Italy is arguably not deserved.

“That's no longer been the case in Italy. Actually, they've been, for them, extremely stable politically over the course of the last couple of years.”at 8:25

Sam Unsted · Bloomberg News

AI borrowers like Microsoft now compete for bond money and look safer than France, which splits investor demand.

Sam says the government bond market is for the first time competing with a new set of borrowers from the AI trade. Investors choosing where to lend can compare France, where political risk is high and the election is unlikely to clear anything up, with companies like Microsoft. Microsoft generates huge amounts of cash and is still growing at roughly 25%, so lending to it looks safer. Hyperscalers need less money than France, but the extra supply still means investors have to divide up limited money and will use any weakness to choose who to lend to.

“Or do you wanna lend that money to Microsoft to just throw off an enormous amount of cash and they're continuing to drive, you know, kind of 25 odd percent growth. So where am I going to put that money?”at 10:41

Sam Unsted · Bloomberg News

French political risk is drastically high with no clear government, driving French bond yields and spreads wider.

Sam argues French bonds are being repriced on politics rather than the debt level. Earlier fiscal debates brought similar, smaller risk-off moves, but this time there is an election next year and no clear government. He says political risk is now drastically high. John Stepek's spread data supports this: the French-German 10-year spread is near 178bp, close to its record of just under 190bp and the highest since the eurozone crisis. Sam says investors are now discriminating within European bonds, with German yields falling while French and Italian yields rise. John adds that the problem is that nobody is clearly in charge and no one knows who will govern in about a year, not that French debt is high. Sam expects clarity to take at least six to eight months.

“incidences have not been accompanied by an election next year. And so the political risk in France is now, I mean, really quite drastically high.”at 4:34

Sam Unsted · Bloomberg News

Ahead of the budget, UK ministers' fiscal-rules commitment is calming gilt investors, who are not very worried.

Sam says the UK chancellor John Healey and Andy Burnham have been very clear that they will stick to the fiscal rules and find a way to do what they want without upsetting the bond market. Earlier comments about finding flexibility in the fiscal rules caused some nervousness, but less than before. Most investors are not very worried and expect things to be okay, so the market's worry is focused on France. The result of next week's budget will show whether the commitment holds.

“they have been, Andy Burnham and the chancellor, John Healy, very, very clear. [...] we are going to stick to the fiscal rules, and we are going to find a way to do what we want to do without causing a huge upset in the bond market.”at 7:38

Sam Unsted · Bloomberg News

The ECB is far from intervening, since French yields are not yet disorderly and banks are sturdier than in 2011.

Asked whether the ECB might consider French spreads an existential threat to the euro, Sam says it is a long way off. The eurozone banking problems of the euro crisis were much worse than today, because the system is now more regulated and robust. This is about sovereign debt rather than banks. The spread against Germany has widened, but the actual French yield is still well below crisis levels. The word investors would use for the situation is disorderly, and Sam says the market is not there yet.

“So we're not quite at that kind of, the word I think they would use is disorderly. We're not quite at that kind of point just yet.”at 17:37

Sam Unsted · Bloomberg News

Neoclouds are the most leveraged, fragile part of the AI build-out, so cracks will likely show there first.

Sam argues neoclouds are like very valuable startups, not like hyperscalers. Hyperscalers generate huge cash even with their capex, so they can borrow if they need to. Neoclouds are highly leveraged to how everything goes. They need IPOs to shore up balance sheets so they can keep the investment the AI build-out requires, and recent IPOs in South Korea and Australia have flopped. This makes them the first place cracks could appear, since the build-out may have moved faster than energy and grid capacity can support. John agrees, comparing them to a mortgage on a data centre.

“The neo clouds are, in some respects, they're almost sort of startups, but really big startups or really valuable startups because they are highly leveraged to how everything goes.”at 19:58

Sam Unsted · Bloomberg News

Building enough power capacity to connect AI data centres to the grid is almost impossible, causing delays.

Sam argues that the energy demands of the AI build-out are colliding with grid limits. He says it is almost impossible to build enough energy capacity to connect all these data centres to the grid. That creates delays. Those delays raise the question of whether the build-out can happen on the timescale investors expect, given the hundreds of billions being spent, and the neoclouds are likely to feel the first pushback.

“...which then, as you actually just mentioned as well, energy, just quickly as well, is then bumping up against the, you know, it's just, it is, I would say, almost impossible to build enough energy capacity to actually connect all of these things to the grid as well. So then that creates delays.”at 22:17

Sam Unsted · Bloomberg News

The AI build-out needs copper and other commodities, and building that supply takes a long time.

Sam says the AI build-out is hard to deliver on schedule. Hundreds of billions are being spent on it, but it needs copper and many other commodities, plus grid connectors built around the world. He calls this hard, complicated, long work. Mining companies also need new mines, which is another slow process, so the speed of spending may outpace the physical supply chain.

“You need copper, you need all these different commodities, you need to build out all these connectors to grids all over the world. And it's hard, complicated, long work.”at 23:03