Riding the AI Wave

Federal Reserve Policy & Committee Dynamics

• The April 30 FOMC meeting revealed a divided committee, moving from prior expectations of a single rate cut this year to a more balanced, non-committal stance.
• Recent strong labor market data and the US consumer's resilience have shifted the narrative, contrasting with earlier Fed projections of a "soggy" labor market.
• Four members dissented from the meeting outcome; three advocated for a more nuanced approach that avoids pre-committing to future cuts, while one pushed for an immediate cut.
• Fed Chair Powell confirmed the appointment of Kevin Warsh, who is expected to take a more hawkish stance on inflation than Powell's current dovish tilt.
• Warsh prioritizes the relationship between Fed policy and Treasury issuance, favoring a slower, gradual reduction of the balance sheet to avoid destabilizing the financial system.
• Market pricing currently reflects a bimodal distribution by mid-2027 (either cutting or hiking) that averages to no net movement, with consensus expecting no policy shifts through September.

Macro-Structural Shifts: Leverage & Balance Sheets

• Post-Great Financial Crisis, private sector leverage has materially decreased, reducing market froth and allowing credit and equity markets to disentangle from immediate macro shocks.
• Unlike 2008, current high debt servicing costs in a 2–4% inflation environment are viewed as manageable due to healthier household balance sheets.
• Leverage has shifted to the public sector (government balance sheets), raising concerns about the US ability to sustain further fiscal expansion during future downturns.
• Fixed income markets are sensitive to higher term premiums, which have risen to levels unseen in the last 15 years, reflecting fears over long-term debt sustainability.
• A potential counter-force to debt concerns is the prospect of a productivity boom driven by AI, which could lower the debt-to-GDP ratio if growth accelerates.

Equity Markets & The AI Trade

• The domestic equity market has disentangled from inflation and energy concerns, driven largely by the dominance of hyperscalers, which now comprise over 25% of the market.
• Recent earnings from hyperscalers were received positively, particularly as capital expenditure (capex) growth remained controlled relative to exploding demand for AI tokens and cloud computing.
• Goldman Sachs analysts anticipate a surge in token usage driven by upcoming "world models" later this year, capable of understanding physical laws and interacting with the real world.
• The rebound in equities during April was robust, matching the scale of recoveries seen post-2008 and post-COVID, though the sustainability of this trajectory remains a key question.
• The firm maintains a bullish but cautious stance, holding a 7/10 allocation to tech and waiting for better entry points before increasing exposure.

Investment Strategy & Allocation

• Fixed Income: Explicitly avoided; elevated yields are seen as offering poor growth trajectories compared to the returns available elsewhere.
• Equities: Maintained a 7/10 rating on technology, betting on a generational shift in productivity and global deployment of AI.
• Rotation: Allocated 3/10 to energy and 2/10 to defense, prioritizing energy security and geopolitical stability as dominant themes over the near term.
• Alternative Assets: Maintained low allocations to hard assets and low-obsolescence technologies to hedge against inflation and market volatility.

Forward-Looking Economic Indicators for May & June

• May will serve as a critical early read on US consumer resilience, specifically regarding discretionary spending and the drawdown of savings.
• June is projected to be a potential "air pocket" for growth as airline ticket prices have risen 70%, potentially forcing consumers to cut back on travel despite demographic necessities.
• Summer travel season sentiment data will be a key leading indicator for determining whether the economy continues to hold or faces a slowdown.