Investors and traders are still wondering in awe at last week’s torrid rally for equities that had mega-cap artificial intelligence (AI)-centric stocks back out on leading the charge higher. It was thought earlier this month that there was a “new paradigm shift” in the AI narrative, as if this generational technological transformation had peaked in terms of the stocks pricing in future capital investment, revenues and potential profits.
This skepticism was quickly debunked, and fund flows back in the AI trade were wide open as CEOs of the leading AI companies reinforced the secular spending cycle and widespread applications that are still in their nascent state of development. Case in point, it was reported that Elon Musk’s xAI — the company he launched in 2023 — had brought a massive new training cluster of chips online, claiming it represented “the most powerful AI training system in the world.”
The system, dubbed Colossus, was built at a site in Memphis, Tennessee, using 100,000 chips from Nvidia, specifically its H100 GPUs. Musk said the cluster was built in 122 days and would “double in size” in a few months as more GPUs are added. When Oracle Inc. reported their Q2 results last week, Chairman Larry Ellison claim there was the potential to build 2,000 data centers globally from the 168 it currently operates. These data centers can span three football fields, while others are built to suit smaller sizes. Headlines such as these are reinvigorating the AI fear-of-missing-out (FOMO) trade.
Beyond the new honeymoon with the AI theme, it is being thought that the greater catalyst for the rally was the notion of the Fed possibly front-loading rate cuts by taking the current 5.25-5.50% fed funds rate down by a half-point to 4.75-5.00%. As of last Friday, the bond futures market was showing a 50% probability of a 50-basis point cut at this week’s Federal Open Market Committee (FOMC) meeting. This number is up from 30% a week ago, and 25% a month ago.
This shift marks a rapid about-face for traders, who earlier last week had almost completely discounted the possibility of a large cut in the wake of hotter-than-forecast consumer-prices data and signs the U.S. labor market remains relatively robust. The trigger for the revision was a Wall Street Journal report Thursday that Fed policymakers were considering whether to reduce rates by a regular quarter point or opt for half a percentage point.
The chief U.S economist at JPMorgan Chase & Co. Friday reiterated its call for a half-point cut next week, leading to a volume surge in fed funds futures that would benefit from that outcome. JPMorgan is the lone large Wall Street bank forecasting a half-point rather than a quarter-point cut.
This might be a September to really remember on Wall Street. Following the very tough month of August, history is not on the side of September being any better. And even though the pace of inflation has declined to around 2.5%, it doesn’t reverse the damage done to the majority of American families. The Consumer Price Index (CPI) has increased significantly over the past three years. From 2021 to 2024, the cumulative increase in the CPI is over 21%.
There are red shoots that are sending warning shots over the Fed’s bow of late. Not only is the string of staggering jobs revisions bringing attention to whether the Labor Department can be trusted, the more empirical evidence is seeing delinquencies on consumer debt on the rise. Ally Financial Corp.’s stock was crushed after the consumer lender said delinquencies in its retail car-loan business were up more than expected as people continue to struggle with inflation.
“Over the course of the quarter, our credit challenges have intensified,” Ally Chief Financial Officer Russ Hutchinson said at the Barclays Global Financial Services Conference in New York on Monday. “Our borrower is struggling with high inflation and cost of living, and now, more recently, a weakening employment picture.” Combine this revelation with the prospect of slimmer Net Interest Margin (NIM) for banks, and it might explain why Warren Buffet is dumping his Bank of America position.
The low-income wage earner is on the ropes, lending practices have been looser these past three years than most would admit, Covid payouts have been largely exhausted and consumer credit card debt is at an all-time high with millions of consumers maxed out. Maybe the Fed is finally getting some internal religion and doesn’t want to see the 65% of Americans living paycheck to paycheck and the 47% of Americans that don’t pay any income tax experience a collective tsunami-sized financial meltdown.
That wave seems to be forming out on the horizon, so why wait until it hits the coastline? There seems to be little disagreement that the upper middle-class, more affluent consumers and workers are doing pretty well, enjoying superior asset appreciation from home ownership and stock market gains, but the other much larger swatch of the population is showing evidence of increasing financial strain.
The Fed needs to provide some relief right away and the bond market seems to sense this newfound sense of urgency. Most folks are hardworking and are not looking for a handout, but in these times where inflation has jammed prices of everything higher from much lower levels three years ago, they sure could use a break in interest rates.
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