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The power grid is arguably the backbone of modern society, and we&rsquo;re now at a critical convergence of the demand ramp-up of an increasingly electrified economy and an aging power grid that requires significant improvement, especially in incorporating more renewable but intermittent energy, such as solar and wind.
In addition, a significant bottleneck to the global expansion of data centers &mdash; facilities that organizations use to house their computer systems and related components &mdash; is the availability of power, and the grid is part of that bottleneck. The rapid expansion of data centers, coupled with the broad trend of rising electric vehicle penetration, is lifting power demand far beyond prior expectations.
Much of the grid was built decades ago &mdash; for very different patterns of power supply and demand &mdash; and is need of substantial improvements, including new power line construction and greater grid flexibility. But many obstacles stand in the way of grid modernization: &nbsp;high upfront costs, regulatory and permitting challenges and lack of coordinated planning, not to mention investments in technology and workforce training. There is also a lack of coordinated planning given the fragmented nature of the power sector, with multiple stakeholders and jurisdictions.
Resolving these obstacles requires government support, more private sector participation, and more innovative solutions beyond building more power lines. Governments need to have supportive policies and incentives to speed up grid modernization, such as grants, tax credits and simpler permitting processes. Facilitating public-private partnerships helps to share risks and leverage resources, as investors and project developers have different investment horizons and risk appetites. And yet, amid vast Energy Transition opportunities, which ones are the right ones?&nbsp;&nbsp;&nbsp;
Our new Must C report, Overcoming Gridlock: Powering Our Future, is about finding and evaluating these solutions.

Read the full report <a href="https://ir.citi.com/RFIY0yVkarXqDi9wlMN8WDbZLwUh1rIg3WrWBeinondwWUlq2BvLs-EdgDcS5k2-FSen48XtDwja_Vx4lI06FxLgKvL8xSp0z7v7oz3K9rc%3D" target="_blank" rel="noopener" data-link-source="tiny">here</a>, and listen to our accompanying podcast <a href="https://www.citigroup.com/global/insights/research-citi-e2-gridlock-the-global-power-problem" target="_blank" rel="noopener" data-link-source="tiny">here</a>.

The power grid is arguably the backbone of modern society, and we&rsquo;re now at a critical convergence of the demand ramp-up of an increasingly electrified economy and an aging power grid that requires significant improvement, especially in incorporating more renewable but intermittent energy, such as solar and wind.

Overcoming Gridlock: Powering Our Future

The U.S. asset management industry is in the middle innings of an underlying secular shift toward exchange-traded funds (ETFs). Over the longer term, we expect that traditional mutual funds (MFs) will cede much of their assets under management (AUM) not attached to defined-contribution retirement plans. Advantages of an exchange-traded wrapper, combined with longer-term demographic shifts, will be the ultimate driver of this phenomenon. However, the ETF passive revolution is mostly behind. From here, its evolution will be increasingly down an active path. MF conversions remain topical, but mostly around an offensive vs defensive rationale. The embedded infrastructure related to the advisory channel and its suppliers is an important factor.
Currently there is approximately $25.5 trillion in US mutual fund AUM. Ex&ndash; money market mutual Funds (MMMFs), the amount is closer to $19.5 trillion. This relates to $8.5 trillion in US-listed ETF AUM. We project that $6 trillion to $10 trillion of non-MMMF mutual fund assets represents a potential target for ETF replacement. Of course, this is predicated on current market price levels, so the total could be higher or lower over time as a function of equity and debt market returns.
We have hypothesized in our ETF work over the years that the MF industry is at structural risk to ETFs. But there are gating factors to this. One is related to the nature of retirement plans and their funding. The other pertains to share class structures. That is, where an ETF can be offered as a share class alternative to an existing MF, cannibalization is a lesser issue.
Further, our bigger-picture view has been and continues to be that ETF industry innovation is pushing away from passive index replication and down the active management path. We expect that most new product innovation will be developed around an ETF/exchange-traded wrapper rather than via MFs. Additionally, the past several years of ETF launch activity supports a view that most traditional asset managers will consider augmenting in-house &ldquo;IP&rdquo; or investment acumen via ETFs in a &ldquo;wrapper agnostic&rdquo; manner. Conversions, parallel funds, and newer stand-alone ETFs all fall within this. Increasingly, traditional asset managers are looking for opportunities to invest in private companies alongside public markets as one means of differentiation.
Somewhat related, we suggest that much of the passive tailwind in the decade following the Global Financial Crisis (GFC) can be attributed to benign economic growth where Fed monetary policy struggled to trigger economic activity intended to avert disinflation concerns. During that timeframe, the mega-cap growth cohort of US equities benefited from both outsized earnings growth and the positive valuation read-through from low interest rates. Going forward, higher-than-previous inflation and interest rates could set up for an improved active management opportunity. All told, the next wave of ETF growth should be aligned with an active management bias, thus supporting our contention that traditionally active MFs need to contend/compete/align with exchange-traded alternatives.

Our new Must C report, Sizing the ETF Opportunity: From Passive Revolution to Active Evolution, presents our analysis of this ongoing paradigm shift, including the types of asset managers that will be best equipped to capitalize on it.
Read the full report <a href="https://ir.citi.com/DRbVZZ8xCszeJmQDOf4PVp9xuCpt2xDFa4kkl88nVcMto88u9wnYiSKrkWtv9adibJw7HExmu54bGj8RJK9cJfMSL6-fLMBl9RcMG7K02_1riV3YZ16fIQ%3D%3D" target="_blank" rel="noopener" data-link-source="tiny">here</a>.

The U.S. asset management industry is in the middle innings of an underlying secular shift toward exchange-traded funds (ETFs). Over the longer term, we expect that traditional mutual funds (MFs) will cede much of their assets under management (AUM) not attached to defined-contribution retirement plans.&nbsp;

Sizing the ETF Opportunity: From Passive Revolution to Active Evolution

Global Equities

International Markets

Macroeconomics

China and the U.S. are increasingly jostling over semiconductor intellectual property and manufacturing. The U.S. is seeking to jump-start its own chip production, while using sanctions to blunt China&rsquo;s drive for self-reliance in this critical industry. A new Must C report from a team led by Chris Danely looks at the two powers&rsquo; battle for supremacy.
The semiconductor industry is the driving force behind technological innovations such as artificial intelligence, electric vehicles and factory automation. Consequently, the industry, is crucial to nations&rsquo; economic prosperity and national security. The U.S. accounts for 25% of total semiconductor demand, but its total semiconductor manufacturing capacity is just 12%, down from 37% in the 1990s. This decline has sparked concerns about a threat to national security given China&rsquo;s efforts to gain a significant foothold in the industry.
A key focus of our analysis is the CHIPS and Science Act, which became U.S. law in 2022. Its aim is to boost domestic chip production by earmarking $52.7 billion for allocation over five years to develop domestic manufacturing, as well as R&amp;D and workforce programs. The act provides 25% investment tax credits to semiconductor companies that invest in semis manufacturing or specialized tooling equipment, as noted in our report, conditions introduced by the Commerce Department have made it challenging to turn the act&rsquo;s goals into realities.
Returning leading-edge semiconductor manufacturing to the U.S. could prove extremely difficult. By one estimate, it could cost up to 50% more to make leading-edge chips in the U.S. than in Taiwan. And most semiconductor companies are already raking in profits and don&rsquo;t need extra funding, meaning only less-profitable firms may participate in the CHIPS Act.
The European Union is countering China with the European Chips Act (ECA), which aims to double Europe&rsquo;s share of global chip manufacturing by 2030. The ECA lacks the CHIPS Act&rsquo;s restrictions, and European chip makers seem to have few, if any, reservations on accessing its funding. Meanwhile, Japan&rsquo;s 2022 Economic Security Promotion Act is key to its own effort to establish semiconductor production facilities.
The CHIPS Act isn&rsquo;t the only tactic deployed in the U.S.-China chips rivalry: The U.S. and its allies are also using sanctions as a tool against China. Such restrictions have limited China&rsquo;s ability to acquire and make advanced chips, with an emphasis on items or technologies used for supercomputing and AI training.

Our new Must C report, The U.S.-China Chip Rivalry &ndash; A Battle for Semiconductor Manufacturing Supremacy, also includes a Q&amp;A with semiconductors expert Chris Miller and a graphical overview of the industry.
Read the full report&nbsp;<a href="https://ir.citi.com/kV_qA_ti_-GZ4yZ_bFOrEd7bY1NK-OcvyBfYJpCI7EVhKok24ETi2uL9ngZNZBmi1_XL-0BLJ3Ey-A-kGFSbudPfYcOZCPhrSQpA6Dm1ED53XLaRkhrVFpvUvfr54Cpe" target="_blank" rel="noopener" data-link-source="tiny">here</a>.

China and the U.S. are increasingly jostling over semiconductor intellectual property and manufacturing. The U.S. is seeking to jump-start its own chip production, while using sanctions to blunt China&rsquo;s drive for self-reliance in this critical industry. A new Must C report from a team led by Chris Danely looks at the two powers&rsquo; battle for supremacy.

The U.S.-China Chip Rivalry – A Battle for Semiconductor Manufacturing Supremacy

Our inaugural Must C report looks at the debt situation from historical, international, and macro perspectives, with our analysis organized around 10 key questions. We reach several conclusions, which we explore in more detail in the report:
<ul>
<li>As debt levels rise, we have no way to predict danger thresholds or how much debt is &ldquo;too much.&rdquo; But we think it&rsquo;s unwise for policymakers to experiment or test where these thresholds might be. In our view, the prudent path for fiscal policy is, at a minimum, to not push debt further upward from today&rsquo;s elevated levels. But we admit that we have little hope of meaningful remedial action in the foreseeable future.</li>
</ul>
<ul>
<li>We don&rsquo;t see a full-blown adverse scenario as likely, but last year&rsquo;s UK gilt crisis still stands as a cautionary tale. The hallmark of an adverse scenario would be a sharp, unexpected deterioration in market appetite for Treasuries, leading to sharply higher Treasury yields and rising risk premiums in credit and equity markets. Given the dollar&rsquo;s status as a reserve currency, these stresses would be quickly transmitted to financial markets abroad.</li>
</ul>
<ul>
<li>We think the most likely scenario is that markets&rsquo; discomfort about the U.S. debt trajectory will eventually fade, with the situation broadly reverting to the more relaxed pre-COVID configuration, and only modest premiums will be required to absorb the forthcoming issuance. If we&rsquo;re right, the core strengths of the U.S. economy will give investors the confidence to purchase Treasuries, notwithstanding high debt levels and political noise. And at the end of the day, there are few alternatives to Treasuries.</li>
</ul>

Our new Must C report, The Ever-Rising US Public Debt: Ten Questions &amp; Answers, analyzes the debt situation from multiple perspectives.
&nbsp;Read the full report <a href="https://ir.citi.com/3u9NXj1cXcXmnK86-cXWXCoAIxvpzoYP_g2N61qjA5aS1r41YmEvbPJ6EloxP5TN1Auyuqw1njVBpyrmhSXbd-i_OBNqiBq0kckR2cEsjUZowGwbdUEHox1OQL4TvhQi" target="_blank" rel="noopener" data-link-source="tiny">here</a>.

In recent months financial markets have grappled with concerns about the U.S. government&rsquo;s rising debt, worrying about who will buy the forthcoming issuance of Treasuries (which could total $20 trillion over the next decade) as well as about how much debt is &ldquo;too much.&rdquo; What would a full-blown crisis in the U.S. Treasury market look like, and what could trigger one?

The Ever-Rising U.S. Public Debt – Ten Questions and Answers

&ldquo;Geopolitical risk&rdquo; is a sweeping term that encompasses military confrontations, diplomatic standoffs, cyberattacks, sanctions programs and tariffs, with channels of transmission including global trade, supply chains, capital flows and financial markets &ndash; especially commodities markets. A new Must C report from a team led by Nathan Sheets considers the effects of recent geopolitical shocks, including the Russia-Ukraine war and the escalating conflict in the Middle East. We also discuss longer-term structural developments such as the rise of China and other BRICS nations and the increased prominence of populist political voices. And we consider how investors should navigate geopolitical complexities.
Over the last 50 years, commodities and commodity-producing countries and regions have generally played a central role in the onset and transmission of geopolitical shocks. A key question: How will the ongoing transition to renewables and decarbonization influence this dynamic? While it&rsquo;s plausible that geopolitical pressures will become less frequent, it&rsquo;s more likely that tensions will shift to other goods and services, such as advanced semiconductors, rare earth metals, copper or even the availability of data.
There&rsquo;s a common perception that geopolitical shocks are becoming more frequent and severe, but a look at an index of geopolitical risk prepared by Fed researchers finds little support for that idea. Still, given the array of pressures in play, investors would be well-advised to prepare for the possibility that such pressures may become more intense. Another consideration is that national authorities look to have become more reliant on economic tools to achieve their political objectives &ndash; to note two examples, coordinated sanctions have been a prominent response to Russia&rsquo;s invasion of Ukraine, and the U.S. has made heavy use of economic tools in dealing with China.
From a macroeconomic standpoint, we conclude that geopolitical challenges typically affect the economy as supply shocks and tend to result in slower growth and (at least through a transition period) higher inflation. Unfortunately, this presents central banks with a Hobson&rsquo;s choice: tighten policy to fight higher inflation and so risk further weakening the economy, or ease policy to support economic activity and so risk still higher inflation.
Geopolitical challenges, in our view, have been a reality for generations and are likely to remain one. Investors would be wise to become well-versed about their dimensions and likely implications, taking care to neither underestimate nor overestimate their significance.

Our new Must C report, Geopolitics &ndash; Implications for the Economy &amp; Markets, also looks at the differing effects of geopolitical pressures on developed-market and emerging-market economies and offers an empirical assessment of how markets respond to such shocks. Read the full report <a href="https://ir.citi.com/PA4_8IpLnAeROj0OgAkKBs_ETtiEt9-lS9vnKzEipHvLMxakAt5P-kAUSICmp4oSiYrudXUb5BCUgqNyQmETGEZuuiy3zGKAY5G-1cMIIOE%3D" target="_blank" rel="noopener" data-link-source="tiny">here</a>.

&ldquo;Geopolitical risk&rdquo; is a sweeping term that encompasses military confrontations, diplomatic standoffs, cyberattacks, sanctions programs and tariffs, with channels of transmission including global trade, supply chains, capital flows and financial markets &ndash; especially commodities markets. A new Must C report from a team led by Nathan Sheets considers the effects of recent geopolitical shocks, including the Russia-Ukraine war and the escalating conflict in the Middle East. We also discuss longer-term structural developments such as the rise of China and other BRICS nations and the increased prominence of populist political voices. And we consider how investors should navigate geopolitical complexities.

Geopolitics – Implications for the Economy & Markets

As investors embark on strategies for 2024 &mdash; which is already shaping up to be another year of twists and turns &mdash; what are the most compelling themes that bear watching across the globe? Citi Research&rsquo;s Global Strategy and Macro Group (GSMG) addresses the question in a recently published Must C report led by&nbsp;Dirk Willer, Head of Macro, Asset Allocation, and Emerging Markets Strategy, and Jabaz Mathai, Head of G10 Rates and FX Strategy.&nbsp;
Ten Themes for Investing in 2024
<ol>
<li>
Delayed Easing Cycles &ndash; Citi generally expects developed market (DM) central banks to start cutting rates later than the market is currently pricing in.
</li>
<li>
Higher Inflation Risk Premium &ndash; Breakeven inflation rates compressed substantially in DM bond markets in 2023. As central banks start cutting rates this year, our strategists think the inflation risk premia can rise with easing financial conditions.
</li>
<li>
Diverging Growth, Diverging Central Banks &ndash;&nbsp; Citi expects to see divergence between Norway and Sweden on growth, inflation, and central bank FX activity. On growth, Citi economists see a soft-landing scenario for Norway and rate cuts not starting until the end of this year. This contrasts with a persistent, mild recession in Sweden as high rates weaken private consumption and business investment.
</li>
<li>
Broadening EPS, Broadening Markets &ndash; Our equity strategists see EPS broadening as a key dynamic to watch. Last year, earnings growth varied widely across regions, and was often concentrated in a few key sectors. This year, nearly all major regions should see positive EPS growth, with most sectors contributing positively. The team believes this environment will ultimately favor cyclical markets and sectors.
</li>
<li>
Recession in Mid-2024 &ndash;&nbsp; A recession is our economists&rsquo; base case for the United States, beginning in the middle of the year. The increasing effects of the Fed&rsquo;s aggressive hiking cycle&mdash;including tightening bank lending conditions, signs of strain in lower-income households, and a labor market that may be starting to loosen&mdash;point to gradually mounting recessionary pressures.
</li>
<li>
BoJ to Go Slow &ndash; With the Fed and European Central Bank clearly pivoting their policy stances, there is little pressure on the Bank of Japan to tighten monetary policy further. Our Japan rates strategists maintain their monetary policy outlook, with a baseline scenario of a U.S. recession in mid-2024 and simultaneous termination of Japan&rsquo;s yield curve control and negative interest rate policy in April 2025.
</li>
<li>
Chinese Stimulus &ndash; The worst of China&rsquo;s growth fears are receding as policy kicks into action, albeit selectively, with spending oriented toward the &ldquo;three major projects&rdquo; of social housing, urban-village redevelopment, and dual-use infrastructure (for both everyday and emergency use). That said, our strategists believe private sector sentiment may still struggle to recover, given that December&rsquo;s annual Central Economic Work Conference provided no hint of massive consumption support policies nor new policy indications for the property sector.
</li>
<li>
Good Times in EM &ndash; Our emerging markets strategists see inflation in the region continuing to improve as oil and global food prices have been under downside pressure and likely falling within target ranges. With inflation coming close to target, high real ex-ante interest rates suggest central bank cuts, even if growth does not weaken substantially (though weaker growth should be expected and would of course speed up potential rate cuts).&nbsp;
</li>
<li>
The Elections That Matter &ndash; 2024 is one of the biggest election years in history, with more than half the world&rsquo;s population voting. Even so, many of the elections will not be overly market moving, either because outcomes are already relatively clear&mdash;or relatively benign for markets&mdash;no matter who wins. The biggest exception is the U.S. election. Although that one is far out, our strategists believe hawkish sentiment towards China will be a bipartisan issue. The UK election, which could take place late in the second quarter, may also be relevant in the local context.
</li>
<li>
Energy Infrastructure &ndash; The Energy Transition will have broad demand impacts on commodities, but some could take more time to materialize, given the overlapping use of certain commodities in more traditional sectors currently affected by a weak macro environment. The first one to play out could be U.S. natural gas exports, primarily via liquid natural gas (LNG). Since a new wave of U.S. LNG export terminals should enter into service, then the natural gas demand rise that requires a corresponding supply increase would lift prices.
</li>
</ol>
&nbsp;

Existing Citi Research clients can access the full report, Investing in 2024: Themes and Trades, <a href="https://www.citivelocity.com/t/eppublic/2xIWb" target="_blank" rel="noopener" data-link-source="tiny">here</a>.

As investors embark on strategies for 2024 - which is already shaping up to be another year of twists and turns - what are the most compelling themes that bear watching across the globe? Citi Research&rsquo;s Global Strategy and Macro Group (GSMG) addresses the question in a recently published Must C report led by&nbsp; Dirk Willer, Head of Macro, Asset Allocation, and Emerging Markets Strategy, and Jabaz Mathai, Head of G10 Rates and FX Strategy.&nbsp;

Investing in 2024

The U.S. general elections on November 5 will feature competitive races for control of the White House, the House of Representatives and the Senate. A Biden&ndash;Trump rematch looks likely, despite low national support for both candidates. &ldquo;Double-hating&rdquo; Biden&ndash;Trump voters in six swing states will play a pivotal role in determining the outcome. What happens at the top of the ticket will largely determine down-ballot races for the House and Senate. This leaves the closely divided House a toss-up and gives Republicans an early advantage in the Senate cycle.
The following are some of the major takeaways from our Must C report:
<ul>
<li>
President Biden and former President Trump are the frontrunners for their parties&rsquo; nominations. A majority of pledged delegates will be allocated by mid-March, meaning the window is closing fast for primary voters to choose someone else in either party. As soon as late March or early April, the frontrunners could receive a majority of pledged delegates to become their presumptive party nominees. Barring an unexpected development, Biden and Trump are heading for a rematch. The election calendar also coincides with the legal calendar for Trump&rsquo;s four criminal cases. Trials are expected to last at least two to three months and are unlikely to occur concurrently; no trial will finish before Trump becomes the presumptive nominee.
</li>
<li>
Should either candidate withdraw from the race, how a new nominee is chosen and by whom depends on timing. If that happens before the party convention, a nominee will be chosen based on who can receive a majority of primary delegates, with a competition for delegates if no candidate reaches a majority. If a candidate withdraws before ballots are printed, either the Democratic National Committee (DNC) or Republican National Committee (RNC) will choose a replacement based on party rules. If ballots have been printed but it&rsquo;s before Election Day, the DNC or RNC will choose a replacement but the candidates will remain on the ballots, with Biden or Trump electors told to vote for the replacement during the Electoral College count. If it&rsquo;s after Election Day but before the Electoral College count, it will be up to electors to choose, with the decision going to the House if no candidate receives a majority of the Electoral College. Finally, if such an event happens after the Electoral College count but before the inauguration, the Vice President-elect will become President.
</li>
<li>
The election will come down to tens of thousands of voters in six states: Arizona, Georgia, Michigan, Nevada, Pennsylvania and Wisconsin. Today Trump appears to be the favorite, as he&rsquo;s leading in an aggregate of polls nationally and in five of the six swing states. But Election Day is more than eight months away.
</li>
<li>
Biden&rsquo;s unfavorable rating is 58%, while Trump&rsquo;s is 57%, with 16% of voters disliking both candidates. One of the most important questions for 2024 is what these &ldquo;double-hating&rdquo; voters will do: fall in line, vote for a third-party candidate, or stay home.&nbsp;
</li>
<li>
The close presidential race leaves control of the House too close to call; there&rsquo;s a good chance whichever party wins the White House also wins the House. Meanwhile, Republicans hold a geographic advantage in the Senate; there, Democrats&rsquo; best possible outcome is a 50&ndash;50 split Senate, with the Vice President as the tie-breaking majority. A final factor of note is candidate quality: Republicans have lost several winnable House and Senate races in the past by nominating controversial candidates.
</li>
</ul>
&nbsp;
&nbsp;

Our new Must C report, The U.S. Elections &ndash; Buckling Up for Volatility, also features strategy notes from our analysts spanning a range of assets.
Read the full report&nbsp;<a href="https://ir.citi.com/L9iG9l8CdDJd86zLtMcDATrPu7qzoVl3Zd6Ucy5SkmDFaKxLlwbb0ZhE59jTlnvbRj63kdouvQI1RDZLqpMwAHK2QFQIParM-vPmzqb9HRc%3D" target="_blank" rel="noopener" data-link-source="tiny">here</a>.

The U.S. general elections on November 5 will feature competitive races for control of the White House, the House of Representatives and the Senate. A Biden&ndash;Trump rematch looks likely, despite low national support for both candidates. &ldquo;Double-hating&rdquo; Biden&ndash;Trump voters in six swing states will play a pivotal role in determining the outcome. What happens at the top of the ticket will largely determine down-ballot races for the House and Senate. This leaves the closely divided House a toss-up and gives Republicans an early advantage in the Senate cycle.

The U.S. Elections – Buckling Up for Volatility

Research

In a new Must C report, a team led by Nathan Sheets delves into the global economy&rsquo;s digital transformation, which has seen a shift from ecosystems characterized primarily by flows of physical goods to ones predicated on data and information. A key result of this shift has been increased efficiency, a trend that seems likely to accelerate given the recent emergence of generative AI, or GenAI. The digital economy looks poised to be a key driver of global economic growth through the coming decade.
This digital transformation consists of three related processes: digitization of existing activities; the development and production of physical goods needed to support the digital economy or interact with it; and the emergence of new types of activities that weren&rsquo;t feasible (or even conceivable) in the physical economy. That adds up to an expansive footprint: Roughly two-thirds of the global population accessed the internet last year, and Facebook has 3 billion active users.
There&rsquo;s no settled methodology as to how the digital economy should be defined or measured. For the U.S., a narrow measure puts it at 7% of nominal GDP; a broad measure yields an estimate of more than 20%. But however it&rsquo;s measured, it&rsquo;s clear that the digital economy is expanding rapidly. According to the U.S. Bureau of Economic Analysis, the nation&rsquo;s digital economy grew more than 7% annually during 2017&ndash;2022, vs. 2.2% for the overall economy. The increasing adoption of GenAI should allow this growth differential to continue at least through the coming decade, driving further increases in the digital economy&rsquo;s share of GDP. Indeed, we see few practical limits to how high this share could go.
In our report, we consider developments in key industries that produce digital products &mdash; hardware, software and the internet &mdash; as well as &ldquo;downstream&rdquo; industries feeling appreciable effects, such as electrical equipment, retail, and media &amp; entertainment. AI&rsquo;s rise is driving demand for more sophisticated chips, faster and more flexible networking equipment, and increased data-center capacity, as well as software and internet services. AI-related spending on hardware, software and services could grow 30% annually over the next few years. Downstream firms are also seeing benefits, and the &ldquo;creator economy&rdquo; is transforming advertising, entertainment, and social media. For example, online advertising now accounts for 70% of overall spending on advertising.
The bottom line is that we are optimistic about the opportunities the digital economy and GenAI are likely to bring, though we acknowledge there are challenges to be addressed, from building a supportive legal and regulatory environment to reducing vulnerabilities to deepfakes, hacks and cyberattacks. At the company level, these new technologies will need to be broadly adopted and integrated into existing workflows. This will require investment and training, and rethinking of ways that business is done.

Our new report, The Digital Transformation of the Global Economy, is available in full <a href="https://ir.citi.com/WNQZbZAtdOGI67eBo8Z2lWueZ1F1IULUosPCoUIbxCOvqZZiyktzeR1AZp4gXTi3zUJAspvi10fkKecqqjhyTkNTRyMFeoSre4YjEh5V17asoaVQc4tYXlyUxM7tFKuc" target="_blank" rel="noopener" data-link-source="tiny">here</a>.
&nbsp;
Listen to the related Research @ Citi podcast episode <a href="https://www.citigroup.com/global/insights/e8-the-digital-transformation-of-the-global-economy" target="_blank" rel="noopener" data-link-source="tiny">here</a>.

Riding the Wave of Virtual Progress

In a new Must C report, a team led by Nathan Sheets delves into the global economy&rsquo;s digital transformation, which has seen a shift from ecosystems characterized primarily by flows of physical goods to ones predicated on data and information.

The Digital Transformation of the Global Economy

A reshaping of defense spending over the last decade has bolstered the outlook for legacy defense contractors while letting venture-backed companies begin changing the face of the industrial base ecosystem. In this Must C report we look at the outlook for defense spending and offer insights about Western allies&rsquo; priorities.
A new report from a team led by U.S. Aerospace &amp; Defense analyst Jason Gursky looks at the state of global defense spending, which has been rising since Russia&rsquo;s 2015 invasion of Crimea. Since then, new factors at play have bolstered the outlook for legacy defense contractors and let venture-backed companies begin changing the face of the industrial base ecosystem. At the same time, deficits and debt have continued growing for most Western economies, spurring questions about the sustainability and prioritization of government spending. The report, which draws on views from Citi Research economists and equity analysts, looks at the outlook for defense spending and offers insights about the spending priorities of Western allies in this evolving landscape.
Here are seven takeaways from the report:
Defense-spending scenarios: We consider three scenarios. In the first, spending steps down as the Ukraine conflict is resolved and national security concerns take a step back given other priorities. In the second scenario (our base case), defense spending continues at current levels amid geopolitical concerns, with the composition of that spending shifting from personnel and material to equipment and countries seeking to make spending smarter, including by integrating AI. And in the third scenario, spending increases in both the EU and the U.S., driven by either the onset of some broader or more pronounced conflict or a reframing of the &ldquo;great power&rdquo; competition with China in more military terms.
The great power competition and U.S. spending: The U.S. updates its National Security and National Defense doctrine every four years, with the most recent update in 2022. Doctrine has shifted away from a focus on the war on terror to a seemingly warmer cold war in which nations actively compete for regional and global dominance. The Ukrainian conflict, China&ndash;Taiwan tensions and the Israel&ndash;Hamas conflict are all recent developments motivating U.S. policymakers to prepare to deter and if necessary, fight conflicts on three fronts.
Europe&rsquo;s NATO commitments: NATO member states spending less on defense than their commitments sparked friction in the late 2010s and early 2020s between Europe and the U.S., which consistently spends a greater percentage of its GDP on defense. U.S. criticism of European underspending looked prescient following Russia&rsquo;s 2022 invasion of Ukraine; European countries are now reassessing their capabilities and reinforcing the need for a much stronger European Defense Industrial base, with their spending moving to higher levels.
New spending priorities: Recent conflicts in the Ukraine and the Middle East, as well as China&rsquo;s rise, have brought lessons that have informed spending priorities. In addition to recapitalizing nuclear deterrence capabilities, allies are prioritizing areas including Space, Unmanned Aerial Vehicles and Attritable Aircraft (the latter are unmanned craft that can be reused but are affordable enough to risk losing), AI and Missile Defense. All of these areas are growing more quickly than overall defense spending, and in many cases they&rsquo;re being addressed by both legacy contractors and new entrants, which are often backed by venture capital.
An evolving industrial base: Large defense primes still dominate such well-known platforms as fighter jets, tanks and aircraft carriers. But the Department of Defense (DoD) has been pursuing alternatives as it looks to acquire innovative technologies that could position the U.S. to stay ahead of its peers. New companies have emerged as alternatives to traditional suppliers for the rapid development and deployment of &ldquo;next generation&rdquo; capabilities.
A new catalyst of change: The Defense Innovation Unit (DIU) was created in 2015 as the DoD looked to reengage Silicon Valley and other technology hubs. Its mission focuses on identify technologies that can support DoD efforts and keep those technologies out of adversaries&rsquo; hands. As part of this effort, the DIU provides contracts to keep companies out of the &ldquo;valley of death&rdquo; while awaiting the often-slow contracting process and helps tech companies partner with larger primes.
Venture capital and the ecosystem: DIU successes and a more menacing geopolitical environment have helped drive a resurgence of venture investing in the defense tech sector, with more than $70 billion deployed in the past two years. Most of the large defense primes have established and funded corporate venture arms, allowing them to invest either on their own or together with institutional backers.

The full report, Must C: Money and Might &mdash; Financing the Future of Defense, is available <a href="https://ir.citi.com/xxA_oQFCRY3MwZQG8LjbXdxmhq2RaR2kdctiyZrWUTOqwxaiUqprZ98elWhzVsZt-1G-Tesu-O_YCphKQGLZhVIhUbUOFdvzIzPLw8yWryI%3D" data-link-source="tiny">here.</a>

A reshaping of defense spending over the last decade has bolstered the outlook for legacy defense contractors while letting venture-backed companies begin changing the face of the industrial base ecosystem.

Money and Might — Financing the Future of Defense

Article

In a world hurtling toward a relentlessly connected digital economy, the expectations for how money functions are evolving. Whether domestic or cross-border, we now demand that payments operate seamlessly: instant, available around the clock, intuitive and transparent. But the traditional banking system sometimes falls short of this standard, especially when it comes to international transactions. This raises a fundamental question: can conventional forms of money adapt to the demands of the digital age, or are we on the cusp of a new era where digital currencies will power our financial future? Read the full article <a href="/rcs/citigpa/storage/public/cbs38461_The Evolution to Digital Article_v10.pdf" target="_blank" rel="noopener" data-link-source="tiny">here.</a>

In a world hurtling toward a relentlessly connected digital economy, the expectations for how money functions are evolving.&nbsp;

Money: The Evolution to Digital

Citi’s Research team leverages expertise across all asset classes and regions to provide our clients with independent analysis of financial markets, economies, industries and companies.

The work to expand global power grids appears unable to keep pace with strong demand and supply growth, constrained by supply-chain challenges and many regions' permitting frameworks. A new Must C report from Citi Research explores solutions that could ease grid constraints and accelerate AI deployment and energy-security transitions.

Must C: Overcoming Gridlock 2.0 — Solving Power Bottlenecks to Drive AI & Energy Security

Quick, expert-driven articles that address key financial and economic themes with actionable takeaways, market perspectives, and research-backed insights.

Must C - From Citi Research 

<ul><li>Trump inherits a strong U.S. economy, while the global economy has shown dogged resilience.</li><li>Our “baseline Trump scenario” sees Trump 2.0 policies as a complex mix, with tariffs a major source of uncertainty.</li><li>Tariffs are by the far the largest source of concern for the rest of the world.</li></ul>

In our new Must C report, a team led by Chief Economist Nathan Sheets looks at the economy Trump inherits in his return to the White House and the new unknowns introduced by his reelection.<o:p></o:p>Trump becomes president again with a U.S. economy that has been the best performing among major developed markets, powered by a resilient consumer and a strong corporate sector. Meanwhile, the global economy continues to display dogged resilience and looks poised for another year of near-trend performance.<o:p></o:p>At the same time, Trump brings new unknowns to the economic outlook. We examine a “Baseline Trump Scenario” that includes tariff hikes (especially on China), an extension of the 2017 Trump tax cuts, sharp curbs on immigration, broad deregulation of Biden-era requirements, and a potential boost to animal spirits — emotional factors that influence consumer and investor confidence. We recognize broad uncertainty around each policy area, but offer our best guesses about how these areas will evolve.<o:p></o:p>Our conclusion is that Trump’s policies represent a complicated mix of favorable and adverse supply and demand shocks. For U.S. economic growth, our forecast envisions these effects as perhaps balancing out. For U.S. prices, the effects look to skew toward some moderate upward pressures. The clear implication is that over the coming year, the Fed will need to remain alert for signs of emergent inflation pressures, and monetary policy may need to be a bit tighter.<o:p></o:p>For the rest of the world, Trump’s tariff policies are by far the largest source of concern, with countries subject to tariffs facing an adverse demand shock as their access to the U.S. market diminishes, threatening to weaken growth and lower inflation and possibly requiring non-U.S. central banks to be more stimulative with policies.<o:p></o:p>In our view, an important framing thought is that we’ve already seen Trump in the White House. During his earlier term, he was assertive in his rhetoric and policies but ultimately avoided actions that were seriously disruptive, and the economy and the markets generally performed well during his tenure.<o:p></o:p>Looking around the world, China’s economy faces significant downside risks from the possibility of large tariffs. Europe also faces a range of question marks for Trump’s second term, particularly in the areas of tariffs and security. Many of Trump’s core policy concerns also touch Latin America in one form or another, with Mexico looking most exposed but Brazil and Panama additional names to note.<o:p></o:p>Turning to financial markets, we see little worry for broader U.S. equity indexes in a targeted tariff regime, especially since many corporates were granted carve-outs in Trump 1.0 and companies can pass through these costs. On the other hand, broader tariffs could bring a more meaningful hit to margins. Equity markets outside the U.S. are likely to get hit even harder in various tariff scenarios, and felt sizable headwinds from Trump 1.0 tariffs.<o:p></o:p>From a broad perspective, asset prices in 2025 will be significantly driven by the path of Trump’s policies. Uncertainty is likely to persist and be a feature of Trump’s presidency; Trump seems to thrive in a world of ambiguity in which his political opponents and international counterparts aren’t clear about his next move. In our view, investors who stay nimble but also focused on underlying strong economic fundamentals are likely to reap benefits.<o:p></o:p>The full report, Must C: Trump 2.0 – Expectations for the Economy and Financial Markets, also includes perspectives on Trump 2.0 from other economies and regions and is available <a href="https://ir.citi.com/CQN-iswtGFQCZSCX7ZSmwx8EGfV1V10dJ5MQzYBh-VY7neE2bjaEtWD1PlegBWaJIX_UsmLNscAqevTN1OCD16a_KP9638ISVSYghcJqSBA%3D" target="_blank">here</a>.<o:p></o:p>

In our new Must C report, a team led by Chief Economist Nathan Sheets looks at the economy Trump inherits in his return to the White House and the new unknowns introduced by his reelection.

Trump 2.0: Expectations for the Economy and Financial Markets

<ul><li>The U.S. share of global foreign direct investment (FDI) has risen in recent years, while the European Union, UK and China have seen tepid flows.</li><li>We expect global FDI flows to continue their flat trajectory, averaging around $1.5 trillion annually.</li><li>We see risks skewed toward a strengthening of FDI, though the implications of Trump administration economic policies strike us as a pivotal question for the U.S. economy and the entire global system.</li></ul>

Note to readers: Access the full report <a href="https://ir.citi.com/z_uHeVkh6705ka7JQGF880asUbFP1wAuptreipFTOk2-hz-g0Pw_naIEK7Na0eKbLoAa0OnhSk0aT82zQbwMPXRHQuAFlNJU" target="_blank">here</a>In a new Citi Research Must C report, Chief Economist Nathan Sheets and team look at foreign direct investment (FDI) and the potential global implications of Trump administration policies.&nbsp;As President Trump reconfigures U.S. economic policies, the implications for foreign investment in the U.S. strike us as a pivotal question, with the eventual answer not only influencing the path of the U.S. economy but also having implications for the entire global system. We see several offsetting forces in play. One of President Trump’s explicit objectives is to make the U.S. an attractive target for foreign investment and to incentivize these flows. But the marked rise of policy uncertainty is likely to serve as a disincentive, as foreign investment flows typically gravitate to stable and predictable policy regimes. On balance, we remain cautious about the outlook for foreign investment to the U.S. but also constructive, given our view that the economy’s underlying fundamentals continue to look strong.&nbsp;In our Must C report, we explore the features, role and drivers of global FDI flows, with a particular though not exclusive focus on the U.S. Across the various classes of capital flows, FDI is seen as a powerful driver of economic growth and development. While FDI comes in many forms, it generally entails foreign investors taking relatively large, long-term and stable positions in the recipient country.FDI can be interpreted as a gauge of investor sentiment about a country’s longer-term prospects. FDI is drawn to countries with attractive business climates, a proven commitment to the rule of law, and strong and stable economic performance. But the presence of FDI also helps reinforce favorable economic outcomes and policies, as foreign investors contribute their expertise and resources to bolster an economy’s performance.We note that the U.S. share of global FDI has risen in recent years. We see this increase as reflecting several factors, including ongoing reshoring flows, investment in the chemicals sector (particularly in pharmaceuticals) attracted by cheap and abundant natural gas, the success of the CHIPS and Inflation Reduction Acts, and pull from the burgeoning U.S. AI sector. Favorable U.S. growth prospects have no doubt also played a role.Meanwhile, the European Union (EU), UK and China have endured tepid flows in recent years. For the EU this reflects a cocktail of challenges including weak domestic demand, an uncertain energy portfolio and continuing overhang from the Russia-Ukraine conflict. The UK has faced similar challenges, as well as the long positioning post-Brexit. We see the headwinds for FDI inflows to China as more structural, with investment and sourcing systematically moving away from China as a result of geopolitical pressures and related shifts in firms’ production management strategies.The U.S., EU, UK and China together account for two-thirds of global FDI positions. Our work suggests FDI is drawn to large economies given their generally attractive domestic markets and sizable labor pools. But several trade and financial centers including Luxembourg, Switzerland and the Netherlands hold large positions as well.&nbsp;More broadly, global FDI flows have declined markedly as a share of GDP. These flows averaged 2.5% a year from 2005 through 2017, but have stepped down to around 1.5% since 2018. We see this as a signal of slowing in the globalization process.FDI is ultimately attracted by key features of a country’s economy. These attractors include the size and growth of its markets and the availability of low-cost or highly skilled labor resources. A desire to diversify production or reduce frictions such as transportation costs or tariffs may also be in play.A looming question is the prospect for these flows going forward. A reasonable expectation is that global FDI flows will continue their flat trajectory and average around $1.5 trillion annually. Around this flat baseline, we see risks as skewed toward a strengthening of FDI. First the decline in EU FDI looks to have a cyclical component that could reverse. Second, while the weakness of FDI to China looks more structural than cyclical, we see more upside than downside risks from current levels. Third, we think countries such as Mexico and India are benefiting from a rebalancing of investments as firms diversify their production from China, an important trend that should become more apparent over time.Of course, as emphasized above, a related and if anything more critical set of issues involves the attractiveness of the U.S. as a target for FDI and the global implications of Trump administration policies.

Our new Must C report, Foreign Direct Investment — Global Implications of "America First" Policies, is available in full to existing Citi Research clients <a href="https://ir.citi.com/z_uHeVkh6705ka7JQGF880asUbFP1wAuptreipFTOk2-hz-g0Pw_naIEK7Na0eKbLoAa0OnhSk0aT82zQbwMPXRHQuAFlNJU" target="_blank">here</a>.

In a new Citi Research Must C report, Chief Economist Nathan Sheets and team look at foreign direct investment (FDI) and the potential global implications of Trump administration policies.&nbsp;

Foreign Direct Investment — Global Implications of "America First" Policies

U.S. Infrastructure Investment — A Bigger Role for Private Funding

<ul><li>Funding strategies for U.S. infrastructure have traditionally relied on government funding, but growing budget deficits and evolving needs point to a larger role for the private sector.</li><li>Both public-private partnerships and direct private investment could take an increasing share of infrastructure funding in coming years.</li><li>The establishment of a U.S. sovereign fund to leverage U.S. government assets is an intriguing new vehicle that may have an important role to play. &nbsp;</li></ul>

In a new Must C report from Citi Research, a team led by U.S. Chief Economist Andrew Hollenhorst looks at changing approaches to how U.S. infrastructure projects are funded. These projects involve large upfront commitments of capital and difficult-to-quantify returns that may be spread out over generations.&nbsp;Traditionally, funding strategies have relied heavily on state and local borrowing and direct federal funding. “Natural monopolies” make it most efficient for governments to supply some infrastructure, either directly or in partnership with the private sector, and so create a single connected system rather than disjointed competing ones. Concerns about safety, the environment, security and geopolitics have also made governments critical players in infrastructure investment.&nbsp;But with growing budget deficits and evolving infrastructure needs, we see the private sector and potentially a new U.S. sovereign wealth fund (SWF) taking on an increasingly important role in U.S. infrastructure funding. Direct government funding has been declining for 50 years, with the U.S. government’s share of spending on nondefense infrastructure shrinking from nearly 90% of GDP to about 60%. Today simply maintaining the quality of existing U.S. infrastructure is a challenge: In 2025 the American Society of Civil Engineers gave U.S. infrastructure a grade of C, up from a D+ in 2017 but still barely a passing grade. And that improvement involved historically large post-COVID infrastructure investment programs that are unlikely to be repeated soon.We see three funding models as potentially driving more capital into infrastructure investment. The first model is private-public partnerships, in which private actors share some risk for a project. This model has worked well in some cases, such as private toll roads, but proved difficult to scale up. The second is the new sovereign wealth fund noted above, which might use private-sector funds to leverage existing U.S. government assets, increasing the government’s ability to invest in domestic infrastructure. And the third is direct private investment in infrastructure to support new technologies, with data centers a prime example: We estimate demand related to artificial intelligence (AI) and other new technologies will contribute to data-center capacity more than doubling by 2030.<h2>Private-public partnerships&nbsp;</h2>In this kind of partnership, the private sector takes on some portion of an infrastructure project’s risk, with the private investor receiving compensation from tolls or other revenue produced. Such an approach has made up a relatively small share of total infrastructure investment: In 2017 the Congressional Budget Office concluded that since the early 1990s at most 3% of water and transportation infrastructure investments had taken this form.<h2>Sovereign wealth funds</h2>A distinguishing feature of sovereign wealth funds (SWFs) is a broad mandate to obtain a return on a sovereign’s invested capital. This is different from public pension funds, whose primary objective is to satisfy long-term obligations, implying investments skewed toward long-duration, low-risk fixed-income instruments. SWFs are also distinct from direct holdings of central-bank reserves, which are typically kept in short-maturity local and foreign currency instruments so as to manage liquidity and currency risk.&nbsp;SWFs are relatively new structures, and have usually been associated with countries that run fiscal or trade surpluses, neither of which is true for U.S. at present. But there’s nothing preventing a country like the U.S. from setting up an SWF, and the idea attracted interest from the Biden administration before the Trump administration’s February announcement that it would establish a U.S. SWF, with planning due by May.Treasury Secretary Bessent has indicated the plan is to put “assets to work.” The U.S. Treasury holds $5.7 trillion in assets, with about $3 trillion of that made up of loans and cash and other monetary assets that could be contributed standing up a new SWF. Rather than sell these assets to make investments, the Treasury could borrow against them by issuing debt. Adopting a similar leverage ratio to the European Investment Bank’s 10-to-1 would leave a U.S. SWF controlling $30 trillion in firepower. Even if the SWF primarily invested in foreign-based assets, there would still be capacity to robustly support domestic infrastructure.&nbsp;<h2>Privately-owned infrastructure&nbsp;</h2>The word “infrastructure” is often used as shorthand for “public infrastructure.” There’s no agreed-upon definition of “private infrastructure,” but we might include fixed assets that require a large upfront investment and provide a general economic service needed by other parts of the economy. Examples could be privately owned power generation, communications networks, data centers and electric-vehicle charging stations. Direct private funding of infrastructure is likely to continue to increase in coming years.

A redacted public version of our new Must C report, U.S. Infrastructure Investment: A Bigger Role for Private Funding, is available <a href="https://ir.citi.com/eBEgiE0pZbvLoWaSsWe2QV1PHO21G3Pj25t7c5Qd80ayakzyhcByaIr1wWIUq0GgoKaM9VABwO0_jw4VA98g3x2C17jfxxKb9uyMGCEYGVlmdsu2cqtM8Q%3D%3D">here</a>. &nbsp;

Traditional funding strategies for infrastructure projects rely heavily on state and local borrowing and direct federal funding. But budget deficits and evolving needs suggest a larger role for the private sector, and a new U.S. sovereign wealth fund also may emerge as a vehicle. We explore these new approaches in a new Must C note.

Must C: U.S. Infrastructure Investment — A Bigger Role for Private Funding

<ul><li>President’s Trump second White House term has shifted the global defense-spending landscape and ushered in different priorities from those of President Biden.</li><li>NATO member countries recently announced a higher target for defense spending, with outlays slated to reach 5% of GDP by 2035. But we think further EU incentives and more jointly funded initiatives may prove necessary.</li><li>The White House is looking to shift defense spending to favor weapons-system purchases that better assure warfighters are prepared for conflict, with the fiscal 2026 budget aligned with this view.</li></ul>

Must C: Money and Might 2.0 — Balancing Choices

In a new Must C note from Citi Research, we revisit our October 2024 report on global defense spending to account for how President Trump’s second White House term has shifted the landscape and ushered in different priorities from those of President Biden. As with our earlier report, our goal is to address the outlook for defense spending, provide insight into Western allies’ spending, and assess the players in this evolving landscape.&nbsp;NATO’s recent summit saw member countries announce a new higher target for defense spending, with outlays slated to reach 5% of GDP by 2035. If implemented, this rise in core defense spending would meaningfully raise NATO’s defense capability — though whether the new targets will be met strikes us as an open question. We note European Union (EU) financial instruments such as the Security Action for Europe and the loosening of EU fiscal rules on defense spending, but remain skeptical that the incentives offered will be enough to help persuade more reluctant countries to increase their defense spending significantly beyond the old NATO marker of 2% of GDP. Further incentives and more jointly funded initiatives may be needed.&nbsp;Beyond such incentives, security concerns often collide with economic constraints, as defense-spending goals are challenged by political realities, budget constraints and the significant rise in government debt levels in recent years. While it isn’t prudent to test the limits of markets’ patience with high debt levels, several major countries’ governments seem inclined to do so.&nbsp; Meanwhile, President Trump’s administration doesn’t view the threat environment facing the U.S. much differently than President Biden’s did: Russia, China, Iran, North Korea, and terrorist organizations remain the primary areas of focus. The difference is how these threats are addressed, with a notable shift away from leading European security and toward bolstering security leadership in the Indo-Pacific and fortifying the U.S.&nbsp;This change has driven NATO members’ new commitments but also altered U.S. budgets, with the new White House looking to shift spending to favor purchasing weapons systems that better assure warfighters are prepared for conflict. Defense Secretary Hegseth has endorsed a shift in resources away from support functions and toward warfighting, with the fiscal 2026 budget aligned with this view — an approach we see as supporting the growth outlook for defense names through the rest of the 2020s.&nbsp;While we explore changing White House priorities and geopolitical developments that have arisen since our original report, our October thesis remains intact: Global defense spending has risen over the last decade amid a return to great power competition, with the U.S. looking to leverage non-traditional sources of technological advantage, and conflicts in Ukraine and the Middle East sharpening the focus on such spending. Even as the outlook for legacy defense contractors has been bolstered, venture-backed companies have started changing the face of the industrial base ecosystem, with start-ups seeing a rise in funding and fundraising momentum since the election.Recent developments we consider in this revised report include:&nbsp;<ul style="list-style-type:disc;"><li>In the U.S., we note the 17 key priorities outlined by President Trump’s administration for the Defense Department and shifts we expect to see over time in the types of equipment acquired by the department. We note progress by defense companies that are key to the “Nuclear Triad” ensuring nuclear deterrence across land, air and sea. And we explore evolving U.S. priorities such as artificial intelligence and machine learning; the use of inexpensive UAVs and attritable aircraft; and the “Golden Dome” national missile-defense system. </li><li>In Europe, we consider the step change in defense budgets; where this money will be spent; and how this increased spending will be funded. Europe is seen as not having enough defense equipment, with seven priority areas atop the list of needs that must be addressed. How to pay for this commitment is the next question: While countries such as Sweden and Germany are in relatively robust financial health, others face questions about government debt and fiscal deficits. Europe’s reliance on imported defense products is also a policymaking concern, as technological, productivity and other macro spillovers associated with spending on such products accrue mainly or even entirely to the country producing them. </li><li>In the Indo-Pacific region, both Western and Eastern allies continue to address security risks stemming from China’s military modernization and North Korea’s nuclear missile programs. Countries in the region are deepening trilateral and quadrilateral cooperation, with an accelerating trend toward coalition deterrence. Several countries are also looking to step up as regional stabilizers, seeking to instill order through defense modernization, diplomacy and rules-based advocacy.</li></ul>

A redacted version of our new report, Must C: Money and Might 2.0 — Balancing Choices, is available <a href="https://ir.citi.com/sagtSS11aKo7dnMVDCSzbY11Qsrsj1RGtEAinK6WaSBlkCd3PamV2o5wgOv-FdRPzvSEV64cF9oXYdjETqen4gqgR2ElqDDoIPA61FarP0Kn9y6coJdXSA%3D%3D">here</a>.

We revisit our October Must C report on global defense spending to account for how President Trump’s second term has shifted the landscape. Once again, we explore the defense-spending outlook, offer insight into Western allies’ spending, and assess the players in this evolving landscape.

<ul><li>Artificial intelligence (AI) is a transformative technology with the potential to significantly boost productivity growth, similar to the steam engine, railroad, and internet.</li><li>Despite rapid investment, AI adoption is in its early stages, with only 5% of generative AI (GenAI) projects fully scaled. </li><li>A significant AI-driven productivity acceleration would likely lead to higher real bond yields, lower gold prices, a stronger dollar, and higher equity prices. Yet these effects look, at least in part, to already be priced in. &nbsp;</li></ul>

Productivity & the AI Revolution — Implications for the Economy and Markets

Across the economic landscape, no variable looms as large as productivity growth — it’s the closest thing there is to a “free lunch.” &nbsp;Perhaps a few times a century, the path of productivity is pushed upward by a transformative new technology — the steam engine, the railroad, electrification, the automobile, and the internet are notable examples. &nbsp;We believe artificial intelligence (AI) is likely to soon be added to the list. &nbsp;A new Must C report from Citi Research examines the linkages between U.S. productivity and the emerging AI revolution, addressing questions including whether AI will bring an appreciable uplift to U.S. productivity growth and, if so, when; how large the gains from AI are likely to be; and what the implications are for investors and financial markets. &nbsp; &nbsp; &nbsp;The following are some conclusions that emerge from our work: &nbsp;<ul style="list-style-type:disc;"><li>U.S. productivity growth has bounced back in recent years relative to the lows posted after the global financial crisis. &nbsp;This acceleration is particularly notable in the services sectors. &nbsp;However, the drivers of this rebound look to be more cyclical than structural. &nbsp;As such, we see little evidence to date of a sustained acceleration in productivity as a result of emerging AI technologies.</li><li>The academic literature suggests that roughly 20 to 40% of production tasks could potentially be automated with AI, and the resulting labor cost savings are likely to be around 30 to 40%. &nbsp;This implies a total gain in productivity of 6 to 16%, or a boost to productivity growth averaging ½ to 1½ ppts a year if these gains accrue over a decade.</li><li>We judge that the diffusion of AI is proceeding at a historically rapid pace. &nbsp;With other transformative technologies, meaningful gains often were not reaped until decades after their first introduction. &nbsp;We hypothesize that AI’s comparatively rapid diffusion reflects the highly competitive and fluid nature of the modern economy, as well as the power and accessibility of AI technologies. </li><li>We devise a new measure of U.S. AI investment which draws on widely available macroeconomic data. This measure is centered at $60 billion in 2023:Q4, $150 billion in 2024:Q4, and $255 billion during Q2 of this year. &nbsp;AI investment thus looks to be supporting US economic growth through its demand-side effects. &nbsp;We judge that this upward impulse has been equal to roughly 20 to 40bp in recent years.</li><li>Even so, these are still “early days” for AI adoption. &nbsp;Recent surveys find that only 5% of GenAI projects are fully scaled and creating meaningful value. &nbsp;And there is debate as to whether the recent growth of AI investment will be sustained. &nbsp;Other “speedbumps” that will determine the pace (and extent) of AI diffusion include worker acceptance, the construction of robust physical infrastructure (including sufficient power supplies), steps to ensure the reliability of information, and the creation of supportive legal and regulatory frameworks.</li><li>By our reckoning, AI investment is rapidly approaching levels that characterized the 1990s productivity boom.&nbsp; A straight read-through of our estimates indicates that the United States could see a similar productivity boom within the next few years. &nbsp;However, these estimates are not sufficiently precise — and the lessons of history not sufficiently extrapolatable—to make more specific predictions.</li><li>The further diffusion of AI would also have first-order implications for financial markets.&nbsp; We find that an acceleration in productivity driven by AI advances would bring higher real bond yields and lower gold prices than currently prevail. &nbsp;In principle, it would also mean higher equity prices and a stronger dollar. &nbsp;For these markets, however, such effects look, at least in part, to already be priced in.<ul><li>More specifically, the “AI trade” for equities initially focused on companies producing AI technologies, the AI “enablers.” But the focus is now broadening to include AI “adopters.” &nbsp;As more companies find ways to employ AI technologies, the resulting productivity gains should further propel U.S. equity prices. &nbsp;Even so, this dynamic could leave markets vulnerable if the benefits from AI are less pronounced, or come more slowly, than investors currently expect.&nbsp;</li></ul></li></ul>&nbsp;Bottom line, AI technologies are clearly still in an adoption phase in which the necessary capital—data centers, electrical grid, and hardware—are being developed and built out. &nbsp;In tandem, AI experts are being trained, and workers are adapting to the new technology at varying paces across firms and industries. &nbsp;But, at the same time, the potential productivity benefits from this technology look significant. &nbsp;And the realization of such gains, while still uncertain, strikes us as increasingly likely and proximate.&nbsp;The remainder of the report considers the recent performance of U.S. productivity, develops an estimate of U.S. AI investment, and assesses where we currently stand in the adoption cycle. &nbsp;As part of this discussion, we consider some lessons from history, including the experience of the internet productivity boom and, even earlier, the adoption of electricity. &nbsp;We conclude with reflections on the implications of these developments for financial markets and investor portfolios.&nbsp; &nbsp;

A redacted version of our new report, Must C: Productivity &amp; the AI Revolution — Implications for the Economy and Markets, is available <a href="https://ir.citi.com/onr3Bih0FXUeJsEeuFOxhTPTyU643oEfWLYMsESZq2O7DcdSB0pDet6pQslWBGvSGQ1ePjqbmi9vhRvrBg1GHWK-lA1aYMxmGhm9lU4E6vgdt0X9bbRzlg%3D%3D">here</a>.

Across the economic landscape, no variable looms as large as productivity growth. Will AI bring an appreciable uplift to U.S. productivity growth and, if so, when? What are the implications for investors and financial markets? This latest Must C report examines these questions and more.

The Still-Rising U.S. Public Debt — Twelve Questions & Answers

<ul><li>Concerns are growing in financial markets about the U.S. government’s rising debt, slated to approach 120% of GDP during the coming decade.</li><li>We think it’s unwise for policymakers to test the danger thresholds as debt levels rise, but have little hope that we’ll see a meaningful effort to reduce those debt levels.</li><li>While a full-blown crisis in U.S. Treasuries is possible, we think the most likely scenario is for investors’ concerns to remain a headwind for the economy and markets while proving manageable.</li></ul>

In a new Must C report from Citi Research, Chief Economist Nathan Sheets and a team of economists and macro strategists consider the growing concerns around U.S. public debt. In recent years financial markets have increasingly grappled with the issue of the U.S. government’s bulging fiscal imbalances and rising debt. Who’s going to buy the forthcoming issuance of Treasuries, estimated to exceed $20 trillion over the next decade? How much debt is “too much” — can the debt ratio safely rise another 20%, 50% or 100% of gross domestic product (GDP)? What might trigger a full-blown crisis in the U.S. Treasury market, and what would such an episode look like?The new report, an extension and update to our late-2023 Must C on the same subject, is organized around 12 key questions and looks at the debt situation from historical, international and macro perspectives.U.S. federal debt levels are slated to approach 120% of GDP during the coming decade, far surpassing the post-World War II peak, and these high debt levels — along with entrenched deficits and worries about surging issuance — have exerted upward pressures on Treasury yields in recent years.We judge that President Trump’s “Big Beautiful Bill” (BBB) and tariff revenues combine to leave the U.S. debt trajectory just slightly higher. But the BBB included a range of spending cuts, many with back-loaded start dates, and it remains to be seen if those cuts will be ultimately implemented. Similarly, several of the BBB’s new tax reductions have expiration dates, but history suggests some caution about whether those expirations will come to pass.We can’t predict danger thresholds as debt levels rise, or the amount of debt that’s simply “too much.” But we think it’s unwise for policymakers to test where those thresholds might be. We see the prudent fiscal-policy path as, at minimum, not to push debt levels any higher. A more ambitious path would be a sustained long-term effort to bring debt levels down, through some combination of higher taxes and reduced expenditures. This would put the U.S. economy on a more robust and sustainable footing, but we have little hope that we’ll see meaningful remedial action anytime soon.&nbsp;We don’t think a full-blown adverse scenario is likely, but the 2022 UK gilt crisis offers a cautionary tale. The hallmark of an adverse scenario would be a sharp, unexpected deterioration in the market’s appetite for Treasuries, with sharply higher Treasury yields and rising risk premiums in credit and equity markets. Given the dollar’s status as a reserve currency, these stresses would be quickly transmitted to financial markets abroad.While such a scenario is possible, we think the most likely outcome is that investor concerns about U.S. debt levels remain a headwind for the economy and markets but prove manageable. The U.S. economy continues to possess deep resources and significant strengths. It’s the largest in the world, with engines of growth that have proved resilient and dynamic in recent years, meaning its capacity to pay debt is high. The U.S. private sector is less indebted than those in many similarly situated countries, and U.S. asset positions are strong. And the U.S. dollar remains the world’s reserve currency, with the Treasury market offering investors unique depth and range of instruments. We also think that while the Fed’s independence faces challenges, it will remain well-entrenched, offering an important safeguard against high inflation. Such strengths should give investors the confidence to purchase the debt despite high levels of indebtedness and political noise.The 12 questions and answers posed in the report delve into these issues from a broad range of perspectives, ranging from near-term political dynamics likely to be in play to the implications for the dollar’s status as the world’s reserve currency.

A redacted public version of our new report, Must C: The Still-Rising U.S. Public Debt — Twelve Questions &amp; Answers, is available <a href="https://ir.citi.com/Y219ZHo8knVWJq3Kx8kahdYPCI7h5dt2YpzB8N3h0zKA5-mckE6P6998LQ_W4CaOU7DoT_YtZfLPTVGJ2QuaTo1ydCRxgSnKZOwTleNbykUStUdt3Xq-VQ%3D%3D">here.</a>

Concerns are rising about the U.S. government’s fiscal imbalances and rising debt. Who is going to buy forthcoming Treasuries? How much higher can the debt ratio safely rise? What would a full-blown crisis in the U.S. Treasury market look like, and what could trigger such a scenario? A new Must C report from Citi Research offers questions and answers about this issue, with conclusions about the most likely scenarios we might see.

The Still-Rising U.S. Public Debt: Twelve Questions & Answers

<ul><li>We look at nine potential “wildcard” scenarios that investors should keep in mind for the near future</li><li>None of the nine is among our base cases but any of them could reshape our world. And we note that this decade has already seen a string of unexpected events arrive at a rapid rate.</li><li>We divide our wildcards into three themes the shift from a unipolar world to a multipolar one, asset bubbles popping, and a potential European growth renaissance &nbsp;</li></ul>

Wildcards — Tail Risks in an Increasingly Fragile World

A new Must C report from Citi Research economists and strategists looks at nine potential “wildcards” that investors should be aware of. While none of these scenarios is among our base cases, any of them could reshape our world in the near future. And as we note, the 2020s has seen a string of unexpected events arrive at a rapid rate: COVID, Russia-Ukraine war, the advancement of artificial intelligence (AI), and trade wars.Our wildcards can be assigned to three themes. The first (Wildcards 1-5) concerns the shift from a unipolar to a multipolar world. The second (Wildcards 6-8) is related to asset bubbles popping. And the third (represented by standalone Wildcard 9) is specific to Europe, imagining a growth renaissance that sees the Eurozone economy grow at a faster rate similar to the U.S.<h2>Wildcard #1: Global Fragmentation</h2>U.S.–Europe and U.S.–China trade and political tensions could escalate further and bring about a deeper global fragmentation, pushing tariffs and non tariff barriers sharply higher and accelerating decoupling of economic powers. The U.S., Europe and China are the three largest economies in the world, collectively accounting for nearly 60% of global GDP and 40% of global trade, and this scenario would have material ramifications for the world’s economy. We see trade as the likely first transmission channel, followed by tech, investment, and geopolitics — rare earths, NATO durability, and Treasury holdings all could come into play. Such a scenario would likely mean substantially lower growth in all three economies and worldwide. Supply chains would seize, re routing slowly and imperfectly, with stagflationary pressures rising. Central banks would face a growth/inflation trade off and likely prioritize activity with faster cuts.<h2>Wildcard #2: Perception as Risk — Foreign Buyer Strike Narrative</h2>We don’t expect a structural foreign exit from U.S. fixed income, whose foundational role in global portfolios make such a shift impractical. But we acknowledge the narrative of a “foreign buyer strike” can move markets independently of flows, as seen after last year’s Liberation Day tariffs. Auction takedowns and Treasury International Capital data still signal healthy demand, yet hedged yield math, rising non U.S. sovereign supply, and larger coupon auctions can fuel anxiety. The risk is a duration led shock if foreign insurers pare long end exposure, pressuring utilities, tech, and bank funding curves.<h2>Wildcard #3: Faster Than Expected RMB Appreciation</h2>We think China could accelerate renminbi (RMB) appreciation beyond market expectations (and the conventional wisdom) in an effort to ease trade frictions, advance RMB internationalization, and support “go global” corporate strategies. A stronger currency could be a low cost bargaining chip amid potential Trump–Xi meetings and mounting scrutiny of China’s outsized goods surplus. Policymakers could also seek to enhance the appeal of RMB assets after weak inflows and lackluster China government bond performance in U.S. dollar (USD) terms.<h2>Wildcard #4: Monroe Doctrine Extreme — U.S. Blockades Americas Oil</h2>We consider a scenario in which the U.S. hinders or even stops exports of Latin American — or broader Americas — crude oil to the world. Such a shock would rival the 1973 Arab oil embargo, dislocating benchmarks: Brent/Dubai could spike while WTI/WCS/Mars/Maya would be discounted on captive supply and storage stress. Second order geopolitical responses from China, Europe, OPEC+, and others would add volatility. Over time, energy-security efforts could accelerate, but near term inflation outside the Americas would likely jump while parts of the Americas could see disinflationary pressure.<h2>Wildcard #5: U.S.–Iran War or Iranian Civil Conflict</h2>Our base case is likely pressure without escalation, potentially culminating in de escalation. But paths to conflict remain: strikes on nuclear and energy assets, retaliatory attacks on regional infrastructure, and threats to the Strait of Hormuz. A moderate disruption scenario implies durable risk premia in oil (and possibly greater beta in European natural gas). An extreme case — Strait transit impairment or internal Iranian fragmentation — could deliver substantial supply outages and price spikes.<h2>Wildcard #6: End of the JPY Carry Trade</h2>Relative rates spreads, strong equities and domestic economics could drive a stronger Japanese yen (JPY), especially if hedge ratios or domestic asset allocations shift. Narrow positioning metrics understate the broader system: Japan’s ~¥1,500 trillion in net foreign assets underpin funding across portfolios, with lower foreign exchange (FX) hedging ratios on USD-denominated assets after years of JPY weakness. We forecast sub ¥145/$ against the USD by year’s end, and USDJPY could fall below ¥140 if there’s unwinding of JPY-funded carry trades. JPY carry trades have been structurally built in the global market; an unwinding would cause a far faster and stronger currency appreciation than we currently assume.<h2>Wildcard #7: Bursting AI Bubble, Aggressive Fed Cuts</h2>We see U.S. equities in bubble territory. Bubbles can extend on liquidity, but unwind risks rise if inflation stays sticky and the Fed leans hawkish, or if the return on investment on AI capex disappoints. A sharp drawdown would transmit via wealth effects, risking recession and driving aggressive Fed cuts while Treasuries rally. The USD might weaken with a lag. Equity rotation would likely mirror 2000: out of tech and cyclicals, into defensives and rate sensitives, with geographic diversification offering only limited shelter.<h2>Wildcard #8: AI Hits Credit</h2>We see AI driven disruption as particularly acute for leveraged credit where software and insurance exposures are concentrated, notably in business development companies and loans. Pricing has tracked leverage and market-cap tiers, with smaller, more fragmented software names underperforming. We anticipate a widely dispersed range of outcomes, with AI-related disruption causing both clear winners and losers to emerge; some companies will successfully leverage AI to enhance operations, while others may face obsolescence. This asymmetrical risk-reward profile is particularly problematic for credit instruments, which inherently offer limited upside against significant downside risk. We see two potential avenues for the AI disruption theme to affect financial conditions — through loan ETFs and the generation of collateralized loan obligations (CLOs). While ETFs are only 2% of the loan market, their daily liquidity causes an outsized effect on market conditions. CLOs, meanwhile, are the primary buyer of loans, with 71% of the loan market. Any slowdown in CLO issuance would materially tighten financial conditions for issuers that rely on lenders for capital, which could trigger a cycle of higher distress rates and deeper secondary-market selloffs. &nbsp;<h2>Wildcard #9: EU Exceptionalism — U.S.-Style 2.5% Growth</h2>We consider a low probability but plausible EU economic growth renaissance toward ~2.5% over three to four years. A pivot inward — marked by more fiscal outlays, reshored supply chains, additional capex on multiple fronts — could spark a manufacturing rebound and productivity lift, initially tempering inflation and delaying the European Central Bank’s hawkishness. The equity implications would include faster EPS growth and P/E re rating, narrowing the U.S. premium. FX could respond via flow rotation from U.S. equities, echoing early 2000s dynamics; under similar conditions, EURUSD could appreciate materially, though the path depends on relative policy and inflation trajectories.

A redacted public version of our new report, Must C: Wildcards — Tail Risks in an Increasingly Fragile World, is available <a href="https://ir.citi.com/Pcl0aTPuvf6zZyncT1liRhf4nFRazh4rLihrQNJI_OpiSlJ8sUAz9vvqnr9F7hVgIbhZKgQipkajM3_-sssU4bLcSdezE_v8TiE2ueKc6Nc%3D" target="_blank">here</a>.

Must C

The 2020s have seen “wildcards” arrive at a rapid rate: COVID, the Russia-Ukraine war, AI and trade wars. And we’re only halfway through the decade! In this new Must C report, Citi Research considers more potential wildcards. While not our base cases, all of these scenarios could reshape our world in the near future.

Wildcards: Tail Risks in an Increasingly Fragile World

<ul><li>ETF growth remains strong but is evolving with a maturing industry still on track to reach $25 trillion by 2030 and growth becoming more balanced between organic flows and market returns</li><li>We think flows matter more than markets for long-term outcomes. Across scenarios, changes in flow assumptions have a much bigger impact on future assets under management than return variability.</li><li>Active and differentiated strategies are key to the next phase. ETFs are increasingly the vehicle for accessing underserved asset classes, new investable universes and more tailored exposures. &nbsp;</li></ul>

Must C: Sizing the ETF Opportunity — Active ETFs Move to Center Stage 

A new Citi Research report from a team of strategists led by Drew Pettit explores how the growth of U.S. Exchange-Traded Funds (ETFs) has exceeded the team’s most optimistic expectations, with the main driver organic inflows and not just strong risk-asset returns. Given this reality, the team now revisits its forecasting framework in its new Must C report, updating its aggregate projections for U.S. ETF assets under management (AUM).A year ago, we laid out our roadmap to the next $10 trillion in U.S. ETF assets. Our core thesis was straightforward: ETFs would continue to take share from mutual funds as professional product innovation expanded access to more precisely engineered investment solutions. Central to that view was a slow burn battle for the core of asset allocation itself, where active approaches would begin to reclaim share from traditional index strategies.We saw this shift as driven by growing awareness of the idiosyncrasies embedded in concentrated and widely followed equity benchmarks, pushing investors toward more differentiated, outcome oriented solutions. In fixed income and other asset classes, the story was already unfolding — index approaches often overlooked or underweighted entire segments that offered distinct return streams. Active ETFs benefited directly from this gap, especially as liquidity ecosystems improved, democratized access, and, in some cases, created entirely new investable universes.In our early Must C research (see <a href="https://www.citigroup.com/global/insights/sizing-the-etf-opportunity" target="_blank">Sizing the ETF Opportunity: From Passive Revolution to Active Evolution</a>), we highlighted ETF encroachment on mutual funds, particularly outside of defined contribution channels. Importantly, we never viewed this as simply another wave of passive adoption. Instead, we saw the ETF wrapper becoming the preferred vehicle for active differentiation across asset classes, strategy design, and newly accessible corners of the global opportunity set.While those views were clearly bullish, the industry’s recent growth has exceeded even our most optimistic expectations, with this growth driven largely by organic inflows rather than just strong risk asset returns. Given this reality, we’re revisiting our forecasting framework and updating our aggregate U.S. ETF AUM projections.These are our current scenarios:<ul style="list-style-type:disc;"><li>Base case: $25 trillion in 2030, $42 trillion in 2035. Growth continues but naturally decelerates as the industry matures, with a more balanced mix of flows and returns.</li><li>Bull case: $32 trillion in 2030, $73 trillion in 2035. Overall growth rates resemble the past decade, with organic flows remaining the dominant driver alongside strong market performance.</li><li>Bear case: $20 trillion in 2030, $23 trillion in 2035. New forms of investment funds or investment technologies disrupt the ETF industry, much as ETFs disrupted mutual funds. Growth is largely a function of returns, offsetting outflows in later years — a scenario similar to what we see with mutual funds today.</li></ul>Recent annual U.S. ETF AUM have slightly exceeded our prior bull case. A modeling change reflects this: We now project flows as a percentage of beginning of year AUM rather than extrapolating monthly run rates, which better captures compounding effects in a larger industry.Historically, U.S. ETF AUM has grown at a remarkable 20% annualized pace, with roughly 60% coming from flows. In our base case, we assume meaningful deceleration in flow driven growth as the asset base expands, combined with some minor deceleration in returns. That produces a more even organic inorganic growth split. In the bull case, flows continue to outpace returns as the primary contributor, even while acknowledging ETFs are no longer an early stage industry. In the bear case, the setup increasingly resembles today’s mutual-fund complex, with returns often offsetting negative outflows.Over time, we expect flows as a percentage of AUM to naturally decelerate. Recent years surprised to the upside due to innovation across cryptocurrencies, collateralized loan obligations, and equity derivatives, aided by a more permissive ETF launch environment. When standardized by AUM, however, exponential dollar growth translates into a linear decline in flow intensity — exactly what we’d expect from a maturing industry. Our base case reflects the 10 year historical trend, excluding 2024 and 2025.On returns, aggregate U.S. ETF performance has closely mirrored a globally diversified 60/40 portfolio, averaging 7.3% annualized during the past decade. That serves as the anchor for our assumptions: 6% in our base case, 8% in our bull case, and 4% in our bear case. These sit comfortably within long run historical distributions and imply some modest conservatism amid today’s valuation and rate environment.Ultimately, our earlier forecasts proved conservative because flows, not markets, did the heavy lifting. By reframing growth in terms of flows relative to AUM, we arrive at higher — but we believe more realistic — long term estimates. To us, $25 trillion in U.S. ETF assets by the end of this decade looks clearly attainable, with more than $40 trillion plausible over the next 10 years as innovation continues within an increasingly mature industry.

A redacted public version of our new report, Must C: Sizing the ETF Opportunity — Active ETFs Move to Center Stage, is available<a href="https://ir.citi.com/J-Y51CHv-fMRqIBiZ3N5L4-MLBXEWIasfQMR9GUjacbbRbPp3BvSW0R_fElwvC-GcxSTj_4H8mvdCf5mMroZJguGYO9_PyyNt0vcV9kuvV0%3D" target="_blank"> here</a>.

For analysts, nothing is more satisfying than raising long-term forecasts that had once seemed aggressive, if not unattainable. That’s where we find ourselves today with U.S. Exchange-Traded Funds’ assets under management. Citi Research explores U.S. ETFs’ more mature growth phase in this new Must C report.

Sizing the ETF Opportunity: Active ETFs Move to Center Stage

<ul><li data-list-item-id="ee02756715ac8e60f1bc6ed3031ad24ac">Strong growth in AI, energy security investments, renewables, batteries and EVs is driving sustained demand for power infrastructure and generation equipment</li><li data-list-item-id="e9b75329df1a7dc6b08e16716e2e388e1">Grid expansion is struggling to keep pace with rising power needs, increasing interest in distributed energy solutions and bring-your-own-generation strategies</li><li data-list-item-id="eb69f45bd62b5587e5ab16f406147efa8">Even if AI-related power demand moderates, long-term electrification and energy security trends should continue to support substantial investment across the power value chain</li></ul>

Must C: Overcoming Gridlock 2.0

A new Citi Research report from a team led by Head of Energy Strategy Anthony Yuen looks at the challenges hampering efforts to expand the world’s power grids, work that appears unable to keep pace with strong demand and supply growth. In this Must C report, we examine the evolving power landscape and explore pathways to ease grid constraints while supporting AI deployment and energy-security goals.Demand for power infrastructure and generation equipment continues to rise, driven largely by the U.S.-focused AI data-center buildout, as well as growing concerns around energy security. At the same time, the expanding adoption of renewables, batteries, and electric vehicles is adding to equipment demand. Yet power grids in many regions are struggling to keep pace, constrained by both supply-chain bottlenecks and lengthy permitting processes.As a result, speed-to-power has become a critical priority. Rather than waiting years for new grid connections, many power users are increasingly pursuing distributed solutions and "bring-your-own-generation" (BYOG) strategies, particularly ones based on U.S. natural gas. While grids will continue to expand, demand growth has been far stronger than expected, extending equipment lead times and increasing pressure on existing infrastructure.We believe AI will remain a significant driver of power investment. And even if AI-related demand growth moderates, the broader trends of energy security, electrification, renewable deployment, and EV adoption will still require substantial investment in power infrastructure and generation equipment.To meet these needs, demand is rising for a range of generation technologies, including combined-cycle gas turbines, reciprocating engines, aeroderivative turbines, fuel cells, renewable power, and energy storage systems. In the U.S., many of these solutions depend on natural gas supply, creating potential opportunities across the midstream sector.<h2>Not just about supplying power</h2>Building new power infrastructure is a lot more complicated than simply constructing a power plant and connecting it to the grid. In our view, three challenges increasingly define the landscape: persistent labor shortages, the unique characteristics of AI-driven power demand, and lengthy regulatory and permitting processes. Together, these factors are making it harder to bring new power supplies and data-center projects online, even as demand continues to accelerate.

Research @ Citi Podcast: Watts the Problem?

Labor remains one of the most important constraints. Across much of the world, the market for skilled trades and technical professionals is tight, particularly for occupations that support both data-center and power-infrastructure development.&nbsp;In the U.S., shortages of electricians, lineworkers, construction managers, mechanics, plumbers and other skilled workers are being compounded by simultaneous investment across data centers, utilities, renewables, EV charging networks, semiconductor manufacturing, transmission projects, housing, and public infrastructure. These industries are often competing for the same labor pool. As a result, securing qualified workers can increase costs, extend timelines, and create bottlenecks even when financing and equipment are available.We don’t expect these labor constraints to disappear quickly. Structural factors such as retirements, insufficient apprenticeship pipelines, and growing demand from grid modernization and renewable-energy deployment suggest labor availability is likely to remain a challenge well into the next decade. While initiatives such as expanded training programs, prefabrication, standardized equipment modules, and greater field-service capacity can help, these solutions require time to scale.&nbsp;Labor shortages are also a global issue, although the severity varies by region. Europe, the UK, Australia, and several fast-growing Asian markets face significant shortages of specialized talent, while China appears better positioned from a construction-capacity perspective but still requires advanced engineering and operational expertise.Beyond labor, AI data centers are introducing a new level of complexity into electricity planning. The challenge isn’t simply about growing demand. Rather, utilities and grid operators increasingly must manage three separate dimensions simultaneously: the sheer volume of demand, the ability to deliver power when needed, and the volatility of that demand once facilities are operational.The growth in volume is substantial. U.S. data-center capacity has expanded rapidly in recent years, and new facilities are requiring increasingly large amounts of electricity as computing hardware becomes more powerful. Yet translating this demand into actual operating projects has become difficult. Many proposed facilities face delays or cancellations before construction begins because developers can’t obtain power quickly enough or can’t secure the necessary equipment and approvals. Long waits for transformers, switch gear, generators, and interconnection studies can delay energization even when a project appears viable on paper.These challenges have increased interest in onsite generation, often referred to as BYOG. In many cases, developers are evaluating natural-gas-based generation technologies as a way to bypass grid bottlenecks and accelerate deployment.&nbsp;But the industry remains mindful of historical lessons. The power sector still remembers earlier periods when expectations for future demand resulted in excess generation capacity that later proved unnecessary. As a result, questions around the durability of long-term AI-driven electricity demand remain important when evaluating new investments.Volatility presents another distinct challenge. Unlike many traditional industrial loads, AI data centers can experience significant swings in electricity consumption over relatively short periods, depending on workload intensity. Those changes affect not only computing equipment but also cooling systems and supporting infrastructure.&nbsp;As renewable generation represents a growing share of the power mix, the interaction between variable electricity supply and increasingly dynamic demand adds complexity to grid operations. Utilities are therefore moving beyond traditional planning methods toward more detailed modeling that captures load behavior across different operating conditions, seasons, and weather scenarios.Concerns about grid reliability are also receiving greater attention. System operators increasingly need to account not only for steady demand growth but also for the possibility of large and rapid increases or decreases in load that can affect voltage, frequency, and overall system stability.The regulatory environment adds yet another layer of complexity. Permitting and interconnection processes exist for important reasons, including protecting reliability and ensuring that costs are allocated fairly. However, these processes weren’t necessarily designed for the scale and speed of current demand growth. In some cases, developers have submitted speculative or duplicate connection requests in an effort to secure future capacity, increasing the burden on utilities and grid operators that must evaluate projects that may never ultimately be built.Regulators are responding. In the U.S., policymakers and grid operators are exploring ways to accelerate interconnection timelines while maintaining reliability and protecting consumers from unnecessary costs. A key theme is that large power users may increasingly be expected to fund the infrastructure upgrades required to serve them and, in some circumstances, provide their own generation during periods of grid stress. Similar debates are taking place internationally as governments balance economic development, reliability, affordability, and energy-transition objectives.Stepping back, we believe the core issue is that both electricity demand and electricity supply are growing rapidly, but the systems required to connect them are struggling to keep pace. This dynamic supports continued demand for power infrastructure and generation equipment, while also creating supply-chain bottlenecks that can extend project timelines. In response, developers and policymakers are exploring a wider range of solutions, including flexible computing workloads, improved forecasting and grid modeling, dynamic grid technologies, and efficiency improvements that effectively function as a source of “virtual power.” Together, these approaches may help ease constraints, but they are unlikely to eliminate the need for substantial investment across the broader power ecosystem.&nbsp;

A redacted public version of our new report, Must C: Overcoming Gridlock 2.0 — Solving Power Bottlenecks to Drive AI &amp; Energy Security, is available <a href="https://ir.citi.com/-ipZbZShv8EfrgEUnbwp9btzkQTJtfRm3KNMVxJHRjV1_WNMJjs9z5iyxyf-5R8Qmg00RwGZbgk73zkqddnZJsyoEZi1UH6NmuXfNK-ly-E-k17SDbM6gg%3D%3D" target="_blank">here</a>. You can listen to the accompanying Research @ Citi podcast episode, Watts the Problem?, <a href="https://www.citigroup.com/global/insights/e82-watts-the-problem" target="_blank">here</a>. &nbsp;

Must C - From Citi Research

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Must C: Overcoming Gridlock 2.0 — Solving Power Bottlenecks to Drive AI & Energy Security

Sizing the ETF Opportunity: Active ETFs Move to Center Stage

Wildcards: Tail Risks in an Increasingly Fragile World

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