After a week marked by inflation anxieties and uncertainty about the Federal Reserve's next move, investors are entering a relatively calm five-day period. The spotlight will be on earnings from major retailers and a flurry of manufacturing data. The S&P 500 closed the previous week up 0.4%, the Nasdaq Composite gained 0.6%, while the Dow Jones Industrial Average slipped 0.6%. The past few weeks have been exceptionally busy for market participants. Setting aside breaking news and significant geopolitical developments, a quieter week as summer winds down and children return to school may be exactly what is needed.
While earnings from big-box retailers will dominate the corporate calendar, Chinese tech giant Baidu (BIDU.US) kicks things off on Tuesday, with its AI cloud revenue being a key focus. A wave of retail earnings will follow on Thursday, with Walmart (WMT.US), Alibaba (BABA.US), Ross Stores (ROST.US), and Deere & Company (DE.US) all reporting quarterly results. BJ's Wholesale Club (BJ.US) will close the week on Friday.
On the economic data front, manufacturing indicators will take center stage. The US will release industrial production and manufacturing output figures on Tuesday, followed by the S&P Global US Manufacturing PMI reading on Friday. The calendar also includes housing starts data on Tuesday, which is expected to show a significant decline, and the minutes from the Fed's last meeting on Wednesday.
Stock Market Rises, Yet Sentiment Sours
To put it plainly, market sentiment is in a difficult position. The University of Michigan's preliminary consumer sentiment survey showed that Americans turned more pessimistic about the economic outlook in August, with sentiment declining due to war, rising bond yields, and geopolitical uncertainty. Survey director Joanne Hsu noted that while the early-month weakness in confidence was widespread across demographic groups, it was particularly pronounced among older consumers, those with lower incomes, and individuals without a college degree. These groups are especially vulnerable to the erosion of purchasing power caused by inflation.
This comes after the Bureau of Labor Statistics released monthly Consumer Price Index (CPI) and Producer Price Index (PPI) data, showing only modest improvement in consumer and wholesale inflation. The survey indicated that only 8% of consumers expect their income growth to outpace inflation over the next year. This inflation data was sufficient for traders to reduce their bets on a Federal Reserve rate hike at the September meeting. Before this data was released, market bets were roughly split 50/50, given the much weaker-than-expected July jobs report. Now, the market sees a roughly 70% probability of the Fed holding rates steady. Adding to the bearish signals, the Commerce Department's retail sales data for July showed a 0.6% month-over-month decline, disappointing against market expectations of a 0.1% increase, sustaining concerns about the real purchasing power of consumers.
AI Capital Expenditure Collides with the Real Economy
As earnings season draws to a close, new and larger projections are emerging for how much the hyperscale cloud giants will spend on AI data center construction this year. Goldman Sachs estimates this figure could reach $1 trillion globally by 2026. JPMorgan Chase forecasts US market spending will hit $697 billion, while Bank of America Merrill Lynch sees a "path to roughly $1.2 trillion" by 2027. However, money alone is not the solution, as the bottlenecks are not financial. Despite investments in new manufacturing capacity, chip shortages persist. Construction contractors point to a lack of skilled labor, preventing them from completing projects within client timelines. Furthermore, regulatory restrictions are increasing due to public backlash against data centers, including a year-long moratorium in New York State and audits of power access in Texas. Electricity, however, is perhaps the biggest bottleneck of all. BloombergNEF predicts that if growth continues at its current pace, AI data centers will face a power deficit of 19 gigawatts (GW) by 2035. George Janarikas, an analyst at Canaccord Genuity covering power generation companies, stated, "When you put all these factors together—the ambitions of data center companies to secure the power needed to train their algorithms—we firmly believe this will not be achieved at the pace they expect." Wood Mackenzie recently reported that data center power generators are trying to mitigate anticipated rejections by submitting multiple applications to different utility companies. The energy analysis firm suggests that due to these "phantom" applications and submissions from less experienced operators, power companies and grid operators may only approve 28% of the requested power.
Dollar Trapped Between Two Forces
The US dollar is currently caught in a tug-of-war between oil prices and the Federal Reserve, according to a report last week from Jane Foley, Senior FX Strategist at Rabobank. This began with the breakdown of the old relationship between the dollar and crude oil. Historically, crude oil and the dollar often moved in opposite directions. As oil is priced in dollars, a stronger currency puts pressure on the commodity by making it more expensive for buyers. Foley noted that this relationship began to shift in 2022 when Russia invaded Ukraine and the US solidified its position as a major energy exporter. This shift became more pronounced as the conflict in Iran disrupted shipping through the Strait of Hormuz. Rising oil prices were once a clear negative shock for the US economy. However, the Iran conflict, which triggered the largest energy supply crisis in history, has provided an opportunity for major US oil producers to expand output and profit from higher prices, thereby boosting the nation's energy exports. Foley wrote, "As long as shipping through the Strait of Hormuz is restricted, the dollar is likely to maintain a safe-haven premium, supported by the US's status as an energy exporter." However, a countervailing force is the Federal Reserve. The much weaker-than-expected July nonfarm payrolls report and relatively tame July inflation data have prompted investors to lower expectations for rate hikes, removing a key source of support for the dollar. All of this is happening right after the US Treasury conducted a significant intervention in the Japanese yen. Notably, as the administration attempts to set a floor under the dollar, Treasury Secretary Scott Bessent chose to sell euros rather than dollars to purchase yen.
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