As we’ve discussed often here in my daily notes, we need a period of hot economic growth, rising wages (to restore the standard of living), and stable, but higher than average inflation to inflate away debt — not just domestically, but globally.

And indeed, if we look at the policy moves by the Western world, since the covid lockdowns, that seems to have been the plan.  Inflate asset prices.  Inflate the nominal size of the economy.  Inflate away debt.

On that note, the Atlanta Fed’s GDP model now has the U.S. economy running at a 5% growth rate for Q3.  If we add in the inflation rate, that’s over 8% nominal growth.  That’s better than double the nominal GDP growth for the decade prior to the pandemic.  And with that, as you can see in the chart, the debt burden has been shrinking from the pandemic policy-response driven peak.

With that, let’s revisit an excerpt from my June 21 note from last year (2022):   “If there is one common word we hear spoken from policymakers around the world (from the Great Financial Crisis era, through the pandemic and post-pandemic period) it’s coordination.

They have resolved that in a world of global interconnectedness, the only way to avert the spiral of global economic crises into an apocalyptic outcome is to coordinate policies.

With that, the top finance ministers from G7 countries recently met in Germany.  It’s safe to say, they all know that the only way the world can start reversing emergency level monetary policy, while simultaneously running record level debt and deficits, is if the Bank of Japan is running wide-open-throttle, unlimited QE.”

You keep the liquidity pumping from a part of the world that has a long-term structural deflation problem, and that has the biggest government debt load in the world.

The world gives Japan the greenlight to devalue the yen, inflate away debt and increase export competitiveness (through a weaker currency).  They hit the reset button on an unsustainable, debt-laden economy. This script continues to play out.  

Last week, Fitch downgraded U.S. debt.  This morning Moody’s downgraded some banks.

It seems that the fragility of the banking system was well exposed three months ago, when some noisy venture capitalists decided to incite a run on Silicon Valley Bank.

The heavy concentration of uninsured deposits was exposed.  The duration mismatch was exposed (which all banks have, to varying degrees).  But more importantly, they exposed the vulnerability of the banking system to bank runs, from social media-driven mob behavior.

Of course, the shock in the banking system was quickly resolved.  And once again, it was resolved by Fed intervention.

With the above in mind, given the credibility problem these ratings agencies have, and given that the most powerful central banks and governments in the world have spent the better part of the past fifteen years fixing and manipulating markets where they see fit, do these downgrades matter?

If we look to the market reaction, thus far, for answers, it’s a maybe.  Stocks have given up ground since the Fitch downgrade (2% in the S&P, 3% in the Nasdaq).  And the 10-year yield jumped from sub-4% to as much as 4.20% over just a few days.

As for this downgrade of banks, Moody’s cites “funding costs” as a concern.  With the Fed Funds rates having gone from zero to north of 5%, one would expect at some point, the banks would relent and start paying interest to depositors (or lose them to the Treasury market).

With that, the cost of capital is rising (finally) for the banks.  And it’s contributing to tightening credit conditions reported in the recent Fed Senior Loan Officer Opinion Survey (SLOOS).

For the Fed, who have been looking for signs of “lag effects” from their tightening campaign, these downgrades might be among the effects.

On that note, we have the Kansas City Fed’s economic symposium in Jackson Hole, later this month.  This annual event is well attended by the world’s most powerful central bankers and finance officials, and has a history of signaling policy adjustments.  Maybe it will be an “end of the tightening cycle” theme.

We had some very well-placed comments from a voting Fed member this morning, following the Moody’s downgrade, saying they “may be at the point where they can hold rates steady.”

We heard from two cloud giants last week, on Q2 earnings.  Microsoft had record revenues in the quarter.  Google beat on earnings and revenues. 

Today we heard from Amazon.  It was a big quarter.  They exceeded guidance on revenues and operating income.  

And similar to the earnings calls of Microsoft and Google, Amazon’s call was very focused on the generative AI opportunity.

Remember, this is the first quarter we’ve heard from the “big tech” oligopoly (in an earnings call), since Nvidia declared generative AI to be “the beginning of a major technology era” in its May earnings call.

So, what did CEO Andy Jassy have to say about it?   

Amazon is developing “Large Language Models-as-a-Service.”

It takes years and billions of dollars to build large language models (like ChatGPT).  They are enabling customers to apply already developed models to their own proprietary data, which is secured on AWS (Amazon’s cloud).

As he says, “the core of AI is data.  People want to bring generative AI models to the data, not the other way around.”  It’s the only way to keep their proprietary data secure (not leaked into the world).  

With this business, he says they are “democratizing access to generative AI.”

About this LLM-as-Service business they said it’s early, but they expect it to be “very large.”

So, we’ve heard from the top three cloud companies now.  And all of the calls were dominated by the AI opportunity, the new businesses, the investments they’re making, the new customers they’re reaching, and the expanding total addressable market in front of them.

It’s a new high growth business, where their competitive moats will grow only wider.

PS:  I’d like to invite you to join my new subscription service, the AI-Innovation Portfolio.  Join here, and I’ll send you all of the details.