U.S. economic resilience lifts spirits

Making sense of the forces driving global markets

By Jamie McGeever, Reuters Open Interest Markets Columnist 

U.S. stocks and bond yields rose on Wednesday on surprisingly strong job growth and service sector data, which suggests the economy is in decent shape and calls into question how much lower the Federal Reserve needs to cut interest rates.  

I didn't write a column today, but don't worry - here is a link to Monday's, where I highlight the growing doubts around whether U.S. Big Tech's astronomical investments in AI will ultimately deliver the returns investors are banking on. 

I'd love to hear from you, so please reach out to me with comments at jamie.mcgeever@thomsonreuters.com. You can also follow me at @ReutersJamie and @reutersjamie.bsky.social. 

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* U.S. economic resilience

With the U.S. government shutdown now officially the longest on record, there has been hardly any economic data for investors or policymakers to chew on over the past month. But if the latest figures on Wednesday are anything to go by, underlying growth might be stronger than many thought.

Private sector payrolls growth rebounded sharply in October, and services sector activity rose to its strongest in eight months. Market probabilities of a Fed rate cut next month duly fell back to around 65%, and stocks jumped. Let's see if these are backed up by other numbers in the weeks ahead.

* AI 'bubble' debate rages

It's been a strange - and potentially pivotal - week in the world of AI. Most U.S. 'Big Tech' firms have reported strong earnings, and apart from Meta and Microsoft, their share prices have held up despite some froth coming off the market. 

But there are warning signs, certainly regarding valuations if not the technology. CEOs of big U.S. banks are urging caution at these levels, Palantir is trading around 240 times forward earnings, and doubts are gnawing around the huge sums of AI capex. Is it up to Nvidia once again to deliver bumper earnings and soothe everyone's nerves?

* Japanese FX intervention?

Dollar/yen is trading at 154.50, its highest since February, above levels that have previously prompted Tokyo to intervene (around 152.00 in 2022), and appears to have upward momentum. The dollar is on a roll, while the prospect of fiscal easing from Japan's new government is weighing on the yen.

Will Tokyo intervene soon? Based on dollar/yen and momentum, perhaps. It intervened last year in the 158.00-162.00 area, so 160.00 might be a 'line in the sand'. But domestic and relative US-Japanese fundamentals, and capital flows, would have to align for it to be successful. Assuming dollar/yen doesn't leap higher in the coming weeks, let's see what the BOJ does and signals on Dec 19. 

The reaction of most "Magnificent Seven" tech giants' shares to their latest earnings suggests the artificial intelligence boom is far from over. Yet doubts about the future returns from these firms' astronomical AI expenditures are gnawing deeper.

The third quarter earnings season has seen these tech behemoths continue to rake in huge profits and offer sunny guidance. Some investors may baulk at the Mag 7's lofty valuations, but today's tech leaders – unlike the superstar firms of the 1990s dotcom bubble – appear to have sustainable business models. Federal Reserve Chair Jerome Powell reiterated as much last week, saying that their AI investments are a major source of U.S. economic growth.

Just four "hyperscalers" alone - Microsoft, Amazon, Meta and Alphabet - are expected to spend a combined $350 billion this year, and Goldman Sachs estimates global AI-related infrastructure spending could reach $4 trillion by 2030.

The more these firms splurge on data centers, cloud computing capabilities, and the gamut of AI technologies, the loftier investors' expectations will get. At some point, they will be impossible to meet. 

The financial benefits and cost savings for society resulting from that are one thing; which companies actually profit is another. It is important, therefore, to distinguish between "value creation" and "value capture".  

"The value creation is certainly there," says Daniel Keum, associate professor of management at Columbia Business School. "But will that value flow back to the companies that are making these AI investments right now? For me, the clear answer is no."

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