Google and Microsoft Don’t Care About Fed’s 2% Inflation Goal

As the Federal Reserve acknowledges a setback in its inflation fight, one question looms large: Why hasn’t the economy slowed the way policymakers expected?

An underrated factor here is the growing belief that artificial intelligence will transform industry and the many billions of dollars being spent in pursuit of that future. An AI investment boom that eventually leads to a surge in productivity and economic growth might be hugely beneficial for the US, but the timing couldn’t be worse for the Fed with inflation still above its 2% target. And unfortunately for policymakers, companies including Microsoft Corp.,
Alphabet Inc. and Inc. don’t seem to care at all about the level of interest rates.

The timing of key AI milestones has overlapped and interfered with the Fed’s aggressive fight to stamp out price pressures. It was the hot inflation data received in June 2022 that led the Fed to raise its benchmark rate by 0.75% at four consecutive meetings, spooking markets into fearing recession and leading companies to spend cautiously. The revenues of Nvidia Corp. — a bellwether for the AI industry, which depends on its graphics processing units — were down on a year-over-year basis in the quarter ending October 2022.

OpenAI released ChatGPT the following month, sparking the AI frenzy. It took a while for the business world to catch on, but it was clear that the hype cycle had kicked into a new gear when Nvidia’s earnings report in May 2023 included quarterly revenue guidance 50% higher than Wall Street expected, leading the stock to soar nearly 30% in a day.

Markets experienced the best of both worlds for a stretch — growth and inflation that were continuing to slow due to a post-pandemic economic normalization and the Fed’s actions, and a nascent AI boom that was embraced by investors but represented a relatively modest real economic impact in dollar terms.

The big tech companies’ first-quarter earnings reports over the last week or so showed how that has changed. Microsoft, arguably the AI leader that’s set the pace here, reported capital expenditures — the investment bucket into which Nvidia’s products fall — that grew 66% year over year. Google parent Alphabet reported 91% capex growth from a year earlier. Facebook parent Meta Platforms Inc. talked about plans to “invest aggressively” to support AI research and product development. Amazon said it expects “overall capital expenditures to meaningfully increase year-over-year in 2024” as it supports AI-driven usage of Amazon Web Services.

There’s a bit of a “walk and chew gum” story going on with big tech when it comes to AI investments and accepting that their investors don't want them to spend as freely as they did when interest rates were low. That was apparent in the emphasis Meta CEO Mark Zuckerberg put on continuing to focus “on operating the rest of our company efficiently,” or in the fact that Alphabet’s head count has been essentially flat over the past three quarters despite their huge AI push.

Meta’s stock fell more than 10% after Zuckerberg said the company’s AI spending wouldn’t yield much in terms of near-term revenues, while Microsoft’s stock failed to rally despite beating quarterly expectations on sales and profit. The big winner of earnings season so far has been Alphabet, where investors seemed more enthusiastic about cost controls boosting profit margins and its first-ever dividend than future capex.

Such wrinkles notwithstanding, AI-focused spending will amount to tens of billions of dollars in 2024 given the combined impact of big tech’s investments and investors pouring money into startups in the space. Powerful chips that can run AI training and inference models also require the construction of new data centers and investments in electricity generation and transmission. The AI revolution might be headquartered in San Francisco but its tentacles are already pushing out to places such as the southeastern US.

Microsoft, Nvidia, Alphabet and Meta comprise almost 20% of the S&P 500 and have powered the index’s 23% advance since Nvidia’s earnings update last May. A rising stock market is a barometer of the health and direction of the US economy, as well as creating a wealth effect for the millions of Americans that invest in equities. The upshot has been a boost to consumer and business confidence and reduced concern about a recession.

If AI spending and vibes are at least partially why inflation and growth haven’t followed the path expected by the Fed, it’s not clear what policymakers can or should do about it.

Does anyone really think that raising the fed funds rate an additional 50 basis points would keep Microsoft or Meta from battling to capture the AI opportunity? Technological investment cycles are arguably random and unpredictable and not always something a central bank can control. The timing of this one has been unfortunate for the Fed, but the right course of action is to wait it out rather than further squeeze rates-sensitive parts of the economy that are already struggling.

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