It has been quite a week. US voters delivered a midterm result bigger than many expected, AI stocks were hit hard, and yet bond markets barely moved. We caught up with economist Andrew Hunt to make sense of it.

Why did equity markets react and bonds didn’t?

On paper, the midterms should have been bad news for bonds. A Republican president facing a Democratic Congress has historically meant bigger deficits; the Reagan era’s tax cuts without spending cuts gave birth to America’s “twin deficits” and pushed real yields higher. Bond yields had already been rising as central banks and commercial banks stepped back from buying government debt and households saved less.

Yet yields held steady. Andrew sees two reasons. First, a flight to safety: in a single session, the fall in one leading AI chipmaker’s market value was comparable to a 60% fall in the entire UK share market. Second, and more important, markets suspect the AI investment boom is losing its funding. The private-credit channels that financed much of it are under strain, and after briefly filling the gap, US banks have started to pull back. Less borrowing means less pressure on bond yields.

Equities face the harder maths. Much of recent US profit growth has come from booming investment, with chipmakers booking sales upfront while their customers spread the cost over about seven years. If investment slows, revenues fall quickly but the depreciation keeps coming, so reported profits can drop sharply.

Why a rotation might be good for investors in the short term and for the world in the longer term

Andrew draws parallels with Japan’s late-1980s boom, when too much was poured into a narrow set of industries. If the AI credit boom fades, pricing power and cash flow shift to the “old economy”: businesses that make things, control their costs and carry little depreciation from past spending.

The bigger prize is productivity. Manufacturing is where productivity, and therefore real wage growth, has historically come from; selling houses to each other is not. A rebalancing towards traded goods could mean stronger household incomes, less dependence on asset prices and, Andrew argues, less polarised societies. Recent surveys show trust in government at record lows. The midterm swing, and the talk of working together that followed, may itself be a sign that voters want this change.

Capital flows and currency markets will tell us where we are going, and how quickly

Andrew is watching three things.

- US bank lending. If big US banks step in to fund the gap left by private credit, this is a mid-cycle correction. If they keep pulling back, expect weaker profits and a bigger reset.

- The yen. In a risk-off episode, Japanese investors bringing money home could drive a sharp yen rally.

- Asian currencies. Longer term, pressure is building for Asian currencies, the yuan especially, to rise in what Andrew half-jokingly calls a possible “Bretton Woods 3”. That would push import prices up in countries like Australia, but help price Western manufacturers back into global markets.

The path may be bumpy. But taking away the curtain of an over-extended credit boom could reveal more than a silver lining. Done well, it may be the start of some genuine economic healing.