The Fed’s balancing act

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Good morning. Oil prices touched $120 a barrel yesterday; little over a week ago, they were $95. This provided a dramatic backdrop for outgoing Fed chair Jay Powell’s swan song press conference (final comment: “I won’t see you next time”) and an avalanche of Big Tech earnings reports. I write about the former below, and Hakyung has a look at the latter in the second piece.

Two other points of interest for Unhedged readers today. Check out the “ask an experts” event on private credit today with our brilliant colleagues John Foley and Sujeet Indap at 1pm London time/8am New York. And my first weekly outing as a regular FT columnist can be found here. Let us know what you think: [email protected]. 

The Fed

Powell’s decision to stay on as a Fed governor when his term as chair expires is, in one sense, a non-story. He has maintained that he will stay on until the Trump administration’s investigation into the central bank (nominally about building cost overruns) is over with finality. The administration, in the person of US attorney Jeanine Pirro, cannot quite shut the door. On closing the Department of Justice probe, she noted that the case was being passed to the Fed’s inspector general and, more importantly, brandished the possibility of reopening it. No finality, Powell stays, the end.

There is a relevant follow-on effect, though. With Powell remaining on the Open Market Committee, there will be no room for Trump’s ultra-dovish temporary appointee Stephen Miran when new chair Kevin Warsh arrives. So the committee will become, for a while, a bit more hawkish than it otherwise would have been.

This comes at a very delicate moment in the back-and-forth between doves and hawks — a balance Warsh will soon have to manage. Everyone on the FOMC (except Miran, who really doesn’t count) agreed on keeping rates unchanged. But three members (Beth Hammack, Neel Kashkari and Lorie Logan) objected to language in the committee’s statement that suggested, by implication, that the next rate move was likely to be down. This is unusual but not surprising. Yes, the textbook says to look through inflation driven by supply shocks such as, say, a war in the Middle East. But the essential corollary is that should long-term inflation expectations start to move up, rates do have to tighten, to defend policy credibility. And while expectations are still at a moderate level, the trend is not great:

This is not the only worry. The oil price is up 24 per cent in 10 days and global inventories are drying up. And in the background there is the little problem that underlying inflation, putting aside tariff and energy effects, was never quite beaten. Services inflation excluding energy and housing has stayed stubbornly above 3 per cent. All of this argues against the bias towards cutting — and indeed for readiness to raise rates, should inflation expectations tick much higher. 

But there are pressures coming from the other direction too. At some point, if the Strait of Hormuz stays shut, the inflation problem will give way to a growth problem. Powell said on Wednesday, quite rightly, that there were no signs that was happening now. Americans are still mostly employed and spending merrily. But if the Fed waits to loosen until signs of a slowdown appear, it could be too late.

This is the tightrope that Warsh will step out on to next month, to the sound of the president demanding lower rates. Warsh will need political skill, the support of his colleagues and luck.

(Armstrong) 

Tech earnings

Four of the Magnificent 7 Big Tech companies — Meta, Alphabet, Amazon and Microsoft — reported earnings yesterday afternoon. There is lots to say, but for now, we will confine ourselves to Alphabet and Meta, the day’s biggest winner and loser, respectively.  

Both companies beat revenue expectations, and operating income rose an identical 30 per cent at each. Both increased their targets for full-year investment spending. And yet, in late trading, Meta fell 7 per cent and Alphabet rose 6 per cent.

The difference comes down to credibility. Both companies are spending mind-bending sums on AI (Google projects capital expenditure of about $185bn this year; Meta, about $135bn). Alphabet, with its cloud services unit, has an AI business model that is easy to understand and, to an extent, already works. With Meta, barring some talk about a more efficient advertising business, it’s much less clear. Muse Spark, its AI model, is not considered cutting edge. This explains the diverging market responses to similar earnings, and the diverging fortunes of the two stocks:

Then there is the shadow of the past. Mark Zuckerberg, Meta’s CEO, chair, founder and controlling shareholder, spent tens of billions of dollars on, and renamed the company after, a project (the Metaverse) that was an unqualified failure. Investors remember this sort of thing. There is a reason that Google shares trade at a big premium to Meta’s.

Wall Street is still more than happy to look past high valuations and underwrite epic bets on the future profitability of AI. But it is not indiscriminate. Some companies are on shorter leashes than others.

(Kim)

One good read

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