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Hey everyone, Hedgie here. Let's get into it!

The Fed held rates steady at 3.5%-3.75% as expected, the first pause after three consecutive cuts at the end of 2025. The statement upgraded its assessment of the economy, noting solid expansion, resilient consumer spending, and growing business investment. Job gains "remained low" but the labor market showed "signs of stabilization." Inflation "remains somewhat elevated."

Two dissents: Stephen Miran and Christopher Waller both wanted a quarter-point cut. That disagreement tells you something about where the committee stands.

Kevin Warsh was nominated to succeed Jerome Powell as Fed Chair. Warsh served on the Fed Board from 2006-2011 and played a key role during the 2008 financial crisis. He's called for "regime change" at the Fed and believes the US is entering a period of higher productivity driven by AI and deregulation, which could support faster growth with contained inflation. He's likely more dovish than Powell on rates, but his influence is tempered by the Fed's structure. The chair gets one vote on a 12-member committee.

The confirmation process could take time. Republican Senator Thom Tillis says he'll block all Fed nominees until the DOJ investigation into Powell is resolved. If Warsh isn't confirmed by May when Powell's term ends, Vice Chair Philip Jefferson would serve as acting chair.

Fourth-quarter earnings are coming in strong. About 80% of S&P reporters are beating estimates. Apple, Meta, Microsoft, and Tesla all reported results that beat expectations.

The reaction was mixed. Microsoft dropped 12% despite the beat, on concerns about robust capital expenditure and slower cloud growth. That's the story this week: the market is starting to ask harder questions about whether AI spending is generating returns.

Tech is still expected to deliver the strongest earnings growth, but the gap with other sectors is narrowing. Eight of eleven sectors are forecast to report higher earnings this quarter. The broadening is real.

This was the week the AI spending narrative started to crack. Microsoft's stock dropped on capex concerns. Nvidia's $100 billion OpenAI deal is reportedly falling apart, with Jensen Huang privately criticizing OpenAI's "lack of business discipline." Oracle announced it's raising $45-50 billion this year to fund AI infrastructure buildouts after reports surfaced it might cut 20-30,000 jobs and sell Cerner to meet its $156 billion in OpenAI-related capex obligations.

Meanwhile, software company loans are melting down. Cloudera's loan dropped 7 cents on the dollar this week. Morgan Stanley recommended shorting AI-exposed credits. One analyst called it "loan-ageddon."

The circular dependencies I've been writing about are starting to show strain. Nvidia sells chips to companies building data centers. Those companies sign contracts with OpenAI. OpenAI pays with money raised from investors including Nvidia. Everyone's balance sheet depends on everyone else's continued access to capital.

India announced a 20-year tax holiday for foreign companies using local data centers to serve global customers. The exemption runs until 2047. Google has committed $15 billion to an AI data center in Andhra Pradesh. Microsoft and Amazon have poured billions into Indian data centers. Adani and Reliance are investing heavily.

The "Indian reseller entity" requirement in the fine print is worth watching. Foreign companies have to work through local partners, which creates leverage for Indian conglomerates. Same playbook China used. Come for the tax breaks, stay because your data and operations are entangled with local interests.

The Fed holding was expected. Warsh being nominated wasn't a surprise either. The real story this week is what's happening in the AI ecosystem.

Microsoft dropped 12% despite beating earnings because the market is finally asking what all this spending is for. Nvidia is backing away from a $100 billion OpenAI investment because even the company selling the shovels has concerns about the business model. Oracle is raising $50 billion and considering massive layoffs to fund infrastructure for a customer that burns $9 billion a year and doesn't expect profitability until 2029.

I've been writing about these dynamics for months. The infrastructure is being built. The demand hasn't materialized. Business AI adoption fell from 14% to 12% last year. Microsoft cut Copilot targets by 50%. Sora usage dropped 32% in January. The gap between what's being spent and what's being returned keeps getting harder to explain.

The broadening in earnings growth is encouraging. Small caps continue to outperform the Magnificent Seven. Eight of eleven sectors posting positive earnings growth suggests the market isn't entirely dependent on mega-cap tech anymore. But the AI leaders that drove the market for the past two years are now the ones facing the hardest questions.

I still think the fundamentals support equities over bonds in this environment. Growth is solid, unemployment is low, the Fed has room to cut. But concentration risk is real. The companies spending the most on AI infrastructure are the ones seeing their stocks punished when investors look at the math. Diversification across market caps and geographies makes sense here.

Stay sharp out there.

Hedgie 🦔

January employment data and ISM Purchasing Manager Indexes.

Source: FactSet, Morningstar Direct, Bloomberg. Bonds represented by the iShares Core U.S. Aggregate Bond ETF.

^{Disclaimer: I'm a hedgehog on the internet, not a financial advisor. Nothing in this newsletter is financial advice. I share what I'm seeing and thinking, but you should always do your own research and consult with a qualified professional before making any investment decisions.}