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Prolonged Iran War Could Hit US Automotive Profits, Volumes, Deutsche Bank Says

Automotive markets in the US and Europe have so far shown surprising resilience in the current macro backdrop, though a prolonged Middle East conflict threatens to dent production volumes and profits, Deutsche Bank said Friday.The US/Israel war with Iran is leading to inflationary pressures across raw materials, logistics, freight, and energy, the brokerage said in a note to clients."Across (original equipment manufacturer) and auto parts, both Europe and the US have been described as surprisingly resilient in the current environment, while China was rather soft domestically with strength in exports," Deutsche Bank analyst Edison Yu said.Although immediate financial impacts from the war this year seem "largely mitigated thus far by existing hedging and pass-through strategies on oil and raw materials," suppliers are aware that a prolonged conflict can affect volumes and profits, Yu wrote.Suppliers are leveraging current product portfolios and production footprint as they seek "secular non-auto growth opportunities," according to the note.The Iran war started at the end of February, disrupting energy shipments at the Strait of Hormuz and leading to price surges. The narrow waterway is the world's most important chokepoint for crude flows. A fragile ceasefire between the US and Iran appears to be holding, though the two sides are yet to finalize a framework to end the conflict despite a series of talks."Higher oil prices are not yet translating into softer consumer demand, but all companies are preparing for adverse impacts should they start to show later in the year," Yu said Friday.In its latest revision this month, industry data and analytics provider IHS appeared to incorporate a "worse production environment" in the latter part of the year, Deutsche Bank said. The firm cut roughly 500,000 units of production for this year, 1.2 million units for 2027, and 800,000 units in 2028 to factor in elevated oil prices, according to the note."From a sentiment standpoint, this directly contrasts with the resilient environment commented by suppliers and OEMs across the board," Yu wrote. "Admittedly, near-term visibility is roughly 10-12 weeks, and we suspect (the second quarter) will shape up solidly, pushing any potential risks off to (the second half of the year) and 2027."

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Update: Rising US Borrowing Costs Won't Slow Massive AI Data-Center Buildout as Potential Profit Outweighs Spending

(Updates with comments from Morgan Stanley starting in 13th paragraph.)Rising interest rates won't stop companies such as Alphabet's (GOOG, GOOGL) Google, Amazon (AMZN) and Microsoft (MSFT) from spending enormous amounts of money to build artificial intelligence data centers because the potential profit far outweighs slightly higher borrowing costs, according to industry analysts.The yield on benchmark 10-year US Treasuries rose to 4.58% on Thursday from 3.96% on Feb. 26 as investors worry that rising inflation could prevent the Federal Reserve from cutting interest rates. Earlier this week, the rate reached its highest level since January 2025. That affects borrowing costs for AI hyperscalers that are on track to spend $800 billion in capital expenditures this year and an additional $1 trillion next year.Rates will rise and inflation will remain a concern as the war in Iran will keep oil above $80 a barrel until February, Peter Tchir, head of macro strategies at Academy Securities, said in an interview with. Still, the expected revenue gain from AI products and services is at this point outweighing concerns that rising rates will dampen the data-center buildout, benefiting companies in and adjacent to the AI space including real estate investment trusts, he said."Right now, the profitability of these data centers and AI, and the perceived profitability, just means that they're not really going to be constrained by 50 or 100 basis points in yield," Tchir said. "These are fairly large bets that this is going to work, and it's going to work in a huge scale, in which case borrowing at 5%, 7% or 9% will turn out kind of trivial."It costs $45 billion to $50 billion to build out 1 gigawatt of data-center capacity, said Mandeep Singh, global head of technology research at Bloomberg Intelligence. SpaceX revealed in its initial public offering prospectus this week that it's renting one of its data centers to Anthropic for $1.25 billion a month, or about $15 billion a year."If it costs $50 billion to build an AI data center, and you're able to generate up to $15 billion in revenue in year one, then it takes three and a half years to get your investment back, and then obviously you'll make returns from year four onward," Singh said in an interview.Analysts agreed that benchmark borrowing costs will continue to rise this year."The bond market is a little bit freaked out, we're seeing inflation and risk in the current environment putting a lot of pressure on longer duration Treasury yields to get to very high levels," Elizabeth Templeton, senior product manager for fixed-income indexes at Morningstar, said in an interview. "Seeing the 30-year yield at 5.1% this week, the highest since 2007, is certainly an indication that there's some worry in the markets right now around inflation. That could certainly continue to impact the 10-year the rest of this year."Smaller AI companies including CoreWeave (CRWV) and Nebius (NBIS) could be affected more by the rise in borrowing costs than hyperscalers Amazon, Google and Microsoft, Bloomberg's Singh said. Those companies and others have already sold $300 billion in debt to fund their AI investments this year, according to Bloomberg News. CoreWeave and Nebius didn't respond to a request for comment.Still, the scale of AI borrowing is so large that it can't be ignored, said Kevin McPartland, an analyst at Crisil Coalition Greenwich. Debt deals that are already underway shouldn't be affected, he said."It doesn't take much of a move when you're talking about billions of dollars of financing to really change the economics," he said. "The devil's advocate would be: These are literally the largest companies in the world that have an incredible amount of free cash flow, and so these are not two- or three-year plans, these are five- and 10-year plans, in which case I'm sure they've modeled out the risk of everything, from interest rates to other geopolitical issues," McPartland said."If you're committed for 10 years to spending tens or hundreds of billions, of course you don't want the cost of financing to go up, but maybe the answer is some short-term slowdowns, but no long-term change in strategic planning."Investors should stay exposed to AI but be more selective, Morgan Stanley analysts said Friday in a note to clients.Increased borrowing costs have led to an uptick in rotation across equities, exposing some weakness in AI-aligned companies, the analysts said. Still, AI earnings were "resilient," volatility is contained, and valuations support staying exposed to the sector. the note said."The recent adjustment does not look like a classic risk-off episode or a wholesale defensive rotation," Morgan Stanley said. "It is better characterized as a selective unwind of crowded AI-led momentum exposure, with higher yields providing an additional tailwind to value."The two main data center REITs -- Equinix (EQIX) and Digital Realty Trust (DLR) -- have been refinancing debt and financing their development at roughly the current level of interest rates for the last couple of years, Jeffrey Langbaum, senior REIT analyst for Bloomberg Intelligence, told.That's dented their earnings growth but hasn't deterred them because the returns they generate from the developments outpace the debt costs, he said. Equinix and Digital Realty didn't respond to requests for comment."The returns they are getting on their developments are well in excess of the costs of capital," he said. "My thesis is that even if overall demand shrinks, they should still be able to get their share because they're keeping the size of their development business at a manageable level and not getting out over their skis and trying to expand too far too fast."Equinix sales in the second quarter that ends on June 30 are pegged at $2.58 billion and adjusted funds from operations are estimated at $11.24 a share, according to estimates compiled by FactSet. If realized, that would be up from $2.26 billion and $9.91 a share, respectively, in Q2 2025.Digital Realty Trust revenue in the second quarter is projected by analysts in a FactSet survey at $1.65 billion, while adjusted funds from operations are seen at $1.80 a share. Sales in Q2 last year were reported at $1.49 billion and AFFO was $1.68 per share.Data-center REITs are seeing a tailwind from momentum behind artificial intelligence expansion, Wells Fargo Investment Institute analysts John Sheehan and Amanda Martinez said in a note to clients earlier this month.REITs have a diverse range of offerings including colocation, which allows for multiple users, from hyperscalers to smaller companies, at a single location and interconnection, which means lower-latency connections and better tenant retention, as "particularly notable features" of some data-center buildouts, the analysts said."We are favorable on the data-center REITs subsector as we believe it possesses durable growth prospects, attractive margins, and solid pricing power," Sheehan and Martinez said in their note. "We also view the sub-sector as an attractive route for gaining exposure to the AI theme within the real estate sector, particularly as AI use cases continue to expand and support sustained demand and pricing power."Academy's Tchir said he expects the 10-year Treasury yield to rise to 5% in the next few months, and that investors are rewarding AI capital spending."We're almost in what I call free money stage, where if you announce $10 billion to spend, your stock goes up $20 billion, so why wouldn't you announce spending?" he said. "We are so underinvested in data centers and AI that even if your project turns out not to be as good as you thought, it's still going to do well, because someone needs that compute right now, and for the foreseeable future."Matthew Leising and Tim WeatherheadPrice: $383.20, Change: $-4.46, Percent Change: -1.15%

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Equities Rise Intraday, Oil Falls as Markets Monitor Middle East Peace Prospects

US benchmark equity indexes were higher intraday, while oil prices fell as traders awaited progress in diplomatic efforts to end the Middle East conflict.The Dow Jones Industrial Average was up 1% at 50,786.6 after midday Friday, after closing at a record high in the previous session. The S&P 500 and the Nasdaq Composite were up 0.7% each at 7,499.5 and 26,464.9, respectively, intraday. Barring communication services and consumer staples, all sectors were in the green, led by healthcare.West Texas Intermediate crude oil was down 0.6% at $95.74 a barrel, while Brent fell 0.2% to $102.37. Both benchmarks were on track for weekly declines."Markets are still searching for signs of progress in a potential deal between the US and Iran," ING Bank said in a report Friday. "While there are signs of optimism, uncertainty reigns."A Qatari negotiating team arrived in Iran Friday in coordination with Washington to help secure a deal to end the conflict, Reuters reported, citing an unnamed source.On Thursday, US Secretary of State Marco Rubio reportedly said there were "good signs" that a peace deal is in sight, but warned that any agreement would be "unfeasible" if Iran insists on controlling shipping through the crucial Strait of Hormuz. Iran is discussing setting up a permanent toll system with Oman to formalize its control of the strait, news outlets reported."No one in the world is in favor of a tolling system," Rubio told reporters, according to CNBC. "It can't happen [and] it would be unacceptable."US Treasury yields were mixed intraday Friday, with the 10-year rate down 2.4 basis points at 4.56% and the two-year rate rising four basis points to 4.12%.Kevin Warsh took charge of the Federal Reserve Friday, replacing former Chair Jerome Powell amid growing signs of division at the central bank as inflation heats up.Fed Governor Christopher Waller said he is prepared to be patient in holding monetary policy at its current restrictive stance as the Middle East conflict continues to evolve."If I believe inflation expectations start to become unanchored, I would not hesitate to support an increase in the target range for the federal funds rate," Waller said. "But at this point, that action is premature."In company news, Dell Technologies (DELL) shares soared 16% intraday, the top gainer on the S&P 500, as Wells Fargo raised its price target on the stock to $270 from $180.Take-Two Interactive Software (TTWO) shares were down 3.6%, the worst performer on the S&P 500. Late Thursday, the video game publisher logged a smaller-than-expected fiscal fourth-quarter loss and said it was on track to launch the highly anticipated "Grand Theft Auto VI" Nov. 19.In economic news, US consumer sentiment declined to a fresh record low in May as people fear that high gasoline prices could erode their purchasing power, according to a survey by University of Michigan."Consumer sentiment fell for the third straight month as supply disruptions in the Strait of Hormuz continue to boost gasoline prices," Surveys of Consumers Director Joanne Hsu said. "The cost of living continues to be a first-order concern, with 57% of consumers spontaneously mentioning that high prices were eroding their personal finances, up from 50% last month."Gold was down 0.5% at $4,519.30 per troy ounce, while silver lost 0.1% $76.66 per ounce.

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