It isn’t much of a stretch to claim that the fate of the US economy and stock market this year – and, maybe, even the November elections – will be determined by the forces arrayed at two consequential meetings held nearly 5,000 km apart.

One was a sales conference on artificial intelligence (AI) that filled a San Jose, California, hockey arena to the brim, the other a conclave on interest rates, inflation and unemployment at the Federal Reserve’s white marble neoclassical headquarters in Washington.

The moods conveyed by the events this past week couldn’t have been more different: rampant optimism in Silicon Valley versus measured restraint at the central bank, which held short-term interest rates high to avoid setting off another wave of fierce inflation.

On Wall Street, which is closely monitoring both the tech economy and the Fed, excitement over the possibilities of AI riches outweighs concerns about interest rates and inflation. The stock market has already soared since the autumn of 2022 and shows every sign of powering higher.

But whether the current bull market has any chance of being sustained will depend in large part on the Fed’s ability to dampen inflation without harming the core of the economy. And excessive exuberance in financial markets could further delay Fed rate cuts, which were expected to begin by now, but are now deemed unlikely to start until at least June. The Fed doesn’t explicitly target asset prices, but it could be forced to hold rates high if it appears that a dangerous bubble is forming.

Yet continued Fed inaction would protract the pain of consumers who have been financing purchases at punishingly high interest rates. Those rates are making the cost of housing and credit and auto loan debt painfully expensive. Quite likely, the debt burden is contributing to dissatisfaction among voters, who give the Biden administration poor marks for the economy. What’s more, if consumers run out of steam, the Fed’s campaign to steer the economy safely towards a low-inflation future could run into serious trouble.

GET BT IN YOUR INBOX DAILY

Start and end each day with the latest news stories and analyses delivered straight to your inbox.

Sign UpVIEW ALL

Consider what happened at the meetings.

AI Woodstock

In a vast space usually reserved for San Jose Sharks hockey games and rock concerts, Jensen Huang, the chief executive of Nvidia, told a standing-room-only crowd of tech developers, investors and corporate executives on Monday (Mar 18) that the future of AI had arrived, right there, in front of them.

Pacing the darkened stage in a black leather jacket, jeans and sneakers, Huang held two prototype circuit boards containing Nvidia’s latest superfast chips. These are “amazing” products, he said. “This right here is, I don’t know, US$10 billion,” he said. “The second one’s US$5” billion.

Customers will pay less off the production line, he said, without saying how much. But no matter. The enormous investments in AI hardware will save companies money, Jensen said, because the new technology is so much faster and more efficient than that of the last generation. And this annual event, which Bank of America has called “AI Woodstock”, was filled with deep-pocketed true believers. Hundreds of companies are already on board, Jensen said, and Nvidia’s chips, components and software will be the vibrant core of AI for years to come.

AI has already taken root in fields as varied as weather forecasting, factory logistics, robotics, health care and asset management. And it’s generating staggering sums of money for the companies building it, swelling Nvidia’s stock market valuation to US$2.2 trillion and accounting for much of the exuberance – irrational or not – that has repeatedly driven the market to new heights this year.

If this Silicon Valley AI gathering was intended to pump up passions for spending, dreaming and investing, whatever the risks or costs, the second meeting, in Washington, was devoted to curbing unwarranted financial enthusiasm.

DC Downer

Short-term interest rates in the United States are high. And they will stay high, at least a while longer, regardless of the burden this is placing on millions of people.

That’s essentially the message that came out of the two-day meeting of policymakers in the Federal Open Market Committee on Wednesday. In their own projections for the months ahead, Fed committee members estimated that the benchmark federal funds rate, now at 5.25 per cent to 5.5 per cent, will fall later in the year, perhaps by a total of 0.75 percentage points by year end.

But in a news conference after the meeting, Jerome Powell, the Fed chair, made it clear that rate cutting depends entirely on how the economy behaves. Recall that rates in the United States were near zero only two years ago, when the Fed started its anti-inflation fight. In June 2022, as the United States was recovering from the Covid-19 pandemic, the Consumer Price Index reached 9.1 per cent, a peak not seen in 40 years. The Fed raised rates sharply and has pinned them for months at a deliberately constrictive level with the intention of taming what the economist John Maynard Keynes called “animal spirits”.

The good news is that the unemployment rate has been below 4 per cent for the longest stretch since the Vietnam War, labour productivity has been rising, and a long dreaded recession hasn’t arrived.

But the Fed’s battle is still incomplete.

“Inflation is still too high,” Powell said. “Ongoing progress in bringing it down is not assured, and the path forward is uncertain.”

Even if it makes the Fed uncomfortable, the stock market is aching to party. Traders seemed to be completely unfazed by Powell’s latest warnings: The S&P 500 closed at a record on Thursday, the day after he spoke.

Fixed-income markets are more cautious, with uncomfortable implications for consumers and political strategists.

The bond market is eyeing the economy warily, bidding longer-term interest rates higher and effectively reversing many of the gains of late 2023. One reason for this is that the bond market is feeling the brunt of the Fed’s quantitative tightening campaign – in which the central bank is shrinking its mammoth balance sheet by allowing up to US$95 billion of bonds to be redeemed each month without reinvestment.

That effort has reduced Fed assets to US$7.82 trillion on Mar 11 from nearly US$9 trillion last year. The Fed is likely to slow the pace of tightening, hoping to avoid disruptions in financial markets, Powell said. But by stopping bond purchases while the Treasury issues larger quantities of securities to finance the nation’s debt, the Fed has, at the margins, contributed to a supply and demand imbalance. That has probably increased longer-term interest rates.

As long as the Fed holds short-term rates high, people with money to lend, including savers who have parked their cash in money market funds, can find great deals. Big money funds tracked by Crane Data are paying an average yield of 5.1 per cent.

But there’s a dark side. High interest rates are a major burden on many American families. Revolving credit card rates have soared above 20 per cent, generating hefty bills on interest alone. Consumers’ monthly payments on credit cards, auto loans and other forms of non-mortgage debt are soaring. Those payments reached US$573 billion in February, according to the Bureau of Economic Analysis, and, in a big shift, they are approaching the US$578 billion in mortgage payments. Rates for new mortgages are so steep that many people simply can’t afford a house at all. The cost of debt is just too high.

On Wall Street, AI aficionados and aggressive stock market investors are already feeling optimistic. The steep rise of the market, led by tech stocks such as Nvidia, AMD, Meta and Microsoft, makes that self-evident. For ordinary people to share in the joy, however, interest rates will need to come down. But rocketing stock prices will make it difficult for the Fed to take action. NYTIMES