April CPI came in hot this morning.

Headline inflation jumped to 3.8% from 3.3%.

Core CPI accelerated to 2.8% from 2.6%. The spike in oil prices is clearly in the inflation numbers. 

But what accompanied the bottom in inflation, which happened before the Iran strikes?

The Fed’s December stop and reverse on the balance sheet — the return to balance sheet expansion (which is inflationary). 

 

And as you can see in the next chart, with the Fed holding the effective Fed Funds Rate at 3.64% throughout the year, today’s 3.8% headline inflation print creates negative real rates (Fed Funds Rate minus headline inflation) for the first time since 2023. 

As you can also see in the chart, the last time real rates dipped into negative territory was late 2019 — and the setup was identical. The Fed flip-flopped — they followed a quantitative tightening campaign by returning to balance sheet expansion, to respond to “strains in the money markets” (i.e. tightening liquidity conditions).

Liquidity tightened. The Fed prioritized liquidity over inflation. Real rates went negative.

All of this comes the week Kevin Warsh takes the helm as Fed Chair. And his view has been, smaller balance sheet, lower rates.

In my last note, we talked about the latest sentiment massage from Trump on Iran.

Last week, it was Operation Epic Fury “is over.”

Though operationally (the reality, the physics) nothing had changed.

And then Sunday afternoon, the ninth sentiment massage of the past ten weeks ended with this…

From Wednesday’s “OPEN TO ALL” peace pivot to Sunday’s public rejection. The sentiment massaging cycles keep getting shorter — six days, then five, then four. The reality on the ground has continued in one direction. 

Then on Sunday night, Netanyahu sat down with 60 Minutes and confirmed the war isn’t over — “it’s not over because there’s still nuclear material, enriched uranium that has to be taken out of Iran.”

Trump reiterated that today, saying the uranium has to come out.

Also, while taking press questions in the Oval Office, Trump said this about the war:  he said he’d expected the stock market to drop 20-25%. He said he was willing to do it because Iran couldn’t have a nuclear weapon and the threat had to be addressed.

The stock market is at new record highs because the geopolitical strategy is fueling a wartime industrial mobilization, and the AI revolution is transforming the economy.

The “boom loop” we’ve been describing is clearly showing up in the numbers. More spending on AI infrastructure is leading to more revenue, is leading to more spending on AI infrastructure. 

More capacity equals more revenue.

With that, the past few weeks have been overwhelmingly about earnings and the state of AI. 

Let’s talk about the big events of this week.  

Kevin Warsh should take the helm as Fed Chair on Friday. The new Fed regime starts, and the globally coordinated central bank era (likely) ends.    

On that note, Bessent is in Tokyo today through Wednesday meeting with the Prime Minister, Finance Minister and Bank of Japan Governor. Aligned partners get U.S. support (security, energy, dollar liquidity).

And the big one:  Trump is due to meet with Xi in China, traveling Wednesday night. And they are said to be bringing a large delegation, cabinet members, and American business leaders. This sounds like the Davos playbook (when they visited the World Economic Forum earlier this year, and set the tone for American leadership).  

Beijing is not Davos. 

As we’ve discussed, the administration has made no secret over the past year that dealing with China’s predatory three-decade economic war is priority number one. And as we’ve discussed, the industrial mobilization under Trump, and the fortification of the Western Hemisphere, seems to be for a bigger confrontation than Iran.

With that, putting the President physically in China introduces unnecessary risk at worst — and at best, reduces control and leverage. Even our trade negotiations (led by Jamison Greer and Scott Bessent) haven’t been IN China. They’ve been in neutral sites (Switzerland, Spain, Malaysia, France).  

Although Trump played up his excitement about the visit today, I suspect the chances of it being cancelled, or postponed (for a second time) are not small. 

We will see.

The question: if it’s pushed again, what will be the reason? 

When the April meeting was pushed “5-6 weeks”, it was said to be conditional on China helping unblock Hormuz. That hasn’t happened.

If it gets pushed again, it reinforces the direction of travel toward confrontation with China.  

While the AI revolution continues to grow the economic and market pie, the geopolitical pie continues to be re-portioned.

Trump has used the past thirteen months to realign the world, away from Chinese influence, and back toward American leadership using the American consumer, security and energy as leverage.

This, as we’ve discussed throughout the past year, is the effort to create the global alignment needed to isolate China, to end China’s multi-decade economic war on the world. 

That said, Europe has to be on board, and yet the leadership in Brussels continues to walk the line of ambiguity, if not testing a plan B where they pursue a “third pole” of global power — which is only viable if they drift into further alignment with China (economically).

With that, Trump has levers to pull, to force their hand. 

The levers:  1) Withdrawing U.S. backstops and enforcing “burden sharing.” That creates massive reindustrialization/spending requirements, which puts pressure on already stressed sovereign balance sheets in Europe. 

2) Iran. The Iran War has created an energy shock that has exposed Europe’s energy dependence.  Europe now pays six times what America pays for natural gas — which puts pressure on already stressed sovereign balance sheets in Europe. 

3) Japan. Over the past week, Japan has intervened to support the yen. Japan’s top currency official said they face no constraints on how often they can intervene, and that it is in daily contact with U.S. authorities. 

Keep in mind, for years one of the quiet pillars of the global financial system has been cheap Japanese money. Near-zero rates in Japan made the yen the funding currency for global risk taking. Borrow yen, convert it, buy higher-yielding assets around the world.

It’s a key source of global liquidity. And when a major source of cheap funding starts to get squeezed, so do markets dependent upon that funding source.

That said, the yen carry trade has been slowly repricing over the past two years by the rising path of Japanese interest rates. And now we have yen intervention, with Washington openly in the loop (the currency market is Bessent’s wheelhouse). 

If this recent currency market action is about repricing one of the cheapest funding channels in the world, thoughtfully, as to not create a global market accident — then where would that funding pressure matter the most?

Europe.

Already vulnerable. Weak growth. An energy problem. Fragile sovereign debt. And a political class that has resisted alignment with Washington.

So, is yen intervention another lever to tighten the screws on Europe?

Maybe.

With that backdrop, let’s consider what has happened in recent days. 

Trump called on Germany’s Merz to fix his broken country. He pulled 5,000 troops out of Germany. Rubio suggested withdrawing 100,000 U.S. troops from Europe.  And then today, he posts this …

 

Great call. Then an ultimatum. Get all 27 EU members to sign off on the U.S./EU trade deal by July 4th, or tariffs “jump to much higher levels.”  There’s no chance that happens.  

On Iran. As of yesterday, Epic Fury “is over” as declared by Trump and Rubio. But operationally (the reality/the physics), nothing has changed.

The damaging energy shock/tax on Europe continues, indefinitely.   

Last week we talked about “the inference inflection.”

Seagate had just told us its top three cloud customers had nearly doubled their remaining performance obligations to $1.1 trillion, and that storage was sold out through 2027.

It was a strong clue that the hyperscalers would guide capex higher when they reported.

They did.

As we discussed, they are spending whatever it takes to build the infrastructure.

Because more supply (more compute) equals more revenue. 

Now the demand side is proving out.

Yesterday Palantir reported the strongest quarter in its history. Revenue grew 85% year-over-year, the fastest pace as a public company. U.S. Commercial revenue grew 133%. U.S. Government grew 84%. And the full-year guidance was raised to 71% growth, ten percentage points above the prior guide.

And this is the graphic that tells the story about the state of AI.

Palantir is now in rare company with Nvidia, Micron and SK hynix (of South Korea) as a rule of 145+ company (a measure of revenue growth + operating margin).  

AI has made each of those four companies faster growing and more profitable — with no end in sight.

So, Palantir is now positioned alongside the chip and memory companies that build the AI revolution — which implies the AI software application layer is part of AI infrastructure.

This is the big takeaway: Agentic AI (which Palantir is building for enterprises) is consuming compute the way data centers consume power.

It’s always on, and always inferencing — the “inference inflection.”

We’ve been building the AI-Innovation Portfolio around this thesis since June 2023. Endless demand drives outsized value at the companies that provide the scarce infrastructure resources of this fourth industrial revolution. Join us here, or click below for more details on how we’re positioned and why.

In my last note we walked through Jerome Powell’s recent FOMC press conference.

The departing Fed Chair was again silent on the balance sheet expansion (for a third consecutive press conference). Meanwhile, they’ve added $170 billion worth of Treasuries since December.

And remember, Powell said in December the expansion would continue “indefinitely.”

Conversely, Kevin Warsh, the incoming Chair, has said publicly the balance sheet needs to shrink.

So, the path of the Warsh-led Fed has been telegraphed. And it’s eleven days away.

As we’ve said often in the post-GFC era of Fed asset purchases (balance sheet expansion) — the resulting liquidity injection tends to make stocks go up.

With that, will stopping and reversing on the balance sheet prick the exuberance of the stock market?

To front-run this debate, Stephen Miran (Trump’s appointed Fed Governor) delivered a speech in late March at the Economic Club of Miami.

He told us how they are positioning this balance sheet regime change.

In this speech (see it here) Miran reframes the entire “reserve scarcity” problem, tying it to bank regulation.

He notes that the “ample reserves” framework Powell uses to justify indefinite balance sheet expansion is not a natural feature of the system. It’s a function of Dodd-Frank and Basel.

Specifically, the liquidity coverage ratio requirements force banks to hold large reserve balances. The internal liquidity stress test standards do the same. Banks are not holding $3 trillion in reserves because they want to. They are holding it because the regulators require it.

So the demand for reserves is dictated by regulation, and that’s the lever the Trump administration intends to pull.

The first item on Miran’s list of paths forward is to ease the liquidity coverage ratio and the internal liquidity stress test standards.

Lower the regulatory demand for reserves.

Then the balance sheet can come down without creating the scarcity that would pressure short-term rates higher and break the funding markets.

Then, as an offset to shrinking the balance sheet, they will lower rates.

So the playbook is deregulate the demand side for reserves, shrink the balance sheet passively, pair it with rate cuts.

What does that mean for markets?

Lower policy rates are a tailwind for equities. The Fed exits the government financing business, which lowers the fiscal profligacy premium embedded in long Treasury yields for the past fifteen years.

Less distortion. More efficient capital allocation.

And the regulatory relief on banks frees up bank lending capacity that has been constrained since 2010. U.S. banks specifically benefit.  The economy benefits as the liquidity that’s been trapped in banks becomes loans to consumers and businesses. 

This is structurally pro-growth, pro-equity, and pro-credit.

The conventional view is that Warsh’s balance sheet reduction threatens markets. The Miran framing makes the case for structural reform/structural strength — which should be good for stocks, good for the dollar and dollar assets.

Yesterday Jerome Powell delivered his last FOMC press conference — and he didn’t say a word about the balance sheet.

Not in the prepared remarks. Not in the Q&A.

Remember, in December the Fed ended its quantitative tightening program (shrinking the balance sheet/withdrawing liquidity from the system) and days later restarted another iteration of expanding the balance sheet/adding liquidity to the system (QE that the Fed wraps in different terminology). 

Since then, the Fed has bought $170 billion of Treasuries. And remember, when this program kicked off, Powell also said this:  “there’s a secular ongoing growth of the balance sheet. And that alone calls for us to increase about $20-$25 billion per month.”

So, it’s ongoing. Indefinitely. 

Now, this is in direct contrast with what Kevin Warsh, the incoming Chair, has said publicly about the balance sheet.  It needs to shrink.

So, the departing Fed Chair says QE forever, to maintain ample reserves in the financial system. The incoming Fed Chair says the opposite. 

One would think this would prompt some questions by the army of financial journalists in the room yesterday.  

Not a peep. 

Meanwhile, the same Fed that is quietly easing through the balance sheet, spent time debating the easing bias language in describing the path of interest rates. Three wanted it removed.

So, some were more hawkish on rates, but somehow fine with pumping $40-$50 billion a month in fresh liquidity via the balance sheet. 

And with all of the discussion about the inflationary pressures in the economy, none were attributed to the Fed’s asset purchases. 

So, why are they doing it? 

Is the departing Fed Chair pre-loading dollar liquidity for his global central bank friends, knowing that the incoming Fed Chair will no longer provide such liquidity without conditions (i.e. requiring alignment with the United States on policy)?

Maybe.

Consider this: Since the Fed restarted balance-sheet expansion in December, Europe has accounted for 98% of dollar swap-line usage. 

Clearly dollar liquidity in Europe is a pressure point.  That’s why European leaders have been openly concerned about this Fed regime change over the past few months, and have even talked about “pooling” dollar liquidity from other central bank partners around the world.

That said, when ECB President Christine Lagarde was asked this morning about the liquidity situation, she said, “we still have an abundance of liquidity.”

Better to watch what they do, not what they say.  

Yesterday we talked about the cleanest signal on the current state of AI demand.  That signal is oversubscribed data storage.

Indeed, the signal from Seagate earnings showed up in today’s earnings reports across the AI kings. 

They guided higher (either explicitly or implicitly). All four of them.

Google announced 2026 capex of as much as $190 billion, up from the $185 billion guide they gave just a few months ago, and said capex will “significantly increase” in 2027.

Microsoft upped 2026 spend to $190 billion and said remaining performance obligations ballooned to $627 billion, up 99% year-over-year. 

Meta raised its 2026 capex range from $115-135 billion to $125-145 billion.

Andy Jassy at Amazon said “the faster AWS grows, the more short-term capex we will spend.”  And then he said the AWS backlog for Q1 is $364 billion plus a $100 billion deal they just announced with Anthropic. That’s demand for compute. That means capex is going up. 

So, the capex fatigue thesis didn’t show up. Instead, it continues to accelerate. And it’s because the demand/the revenue is locked in. They just can’t build the compute capacity fast enough. 

But if there’s a chink in the armor, it’s that capex is starting to eat into free cash flow, until they can actually fulfill on the orders.

And it’s free cash flow that funds the huge buybacks the big tech stocks have done in recent years.

This is of particular interest because it ties directly into what the great macro trader Paul Tudor Jones said in an interview just published yesterday. He talked about the supply of stock coming down the pike with IPOs lining up on the docket. And he talked about the capex commitments from the hyperscalers “already eating into their cash flow.”

So, the broad “equity supply” will be growing, which means funding for the big IPOs will be coming out of existing tech stocks.

For those companies producing scarce inputs in the AI buildout or directly innovating to fuel the AI boom, the tailwinds remain. 

For everything else, capital will be rotating out and toward the IPOs (SpaceX, OpenAI, Anthropic …).

 

Google, Amazon, Microsoft and Meta report tomorrow. Apple on Thursday. The market has been waiting for some sign of capex fatigue for years now.  It hasn’t happened.

And there are no signs of it happening when they report over the next couple of days.

Remember, it was just earlier this year that Google doubled its expected 2026 capex to as much as $185 billion. Meta guided up to $135 billion for the year, a near double of what they spent last year.  Amazon announced $200 billion in capex.

And Andy Jassy said they were “monetizing capacity as fast as we can install it.”

It’s because the “always-on” inferencing phase of AI has arrived. Moreover, it shifted into an even higher gear since early February, as autonomous agents have exploded in numbers — running around the clock, executing tasks, managing workflows, transacting, calling other agents.

It’s a demand explosion.

Every agent is consuming compute, power, bandwidth, and storage — continuously.

This is why the hyperscalers have said they can’t build fast enough.

And maybe the cleanest signal on how it’s all going, is from the storage industry.

In fact, if we look back to early February, we talked about the “Nvidia moment for storage” — the point in time when the world realized AI demand for data storage is endless. SanDisk had just reported $3 billion in revenue and then guided for $4.4 to $4.8 billion the next quarter (a 50% sequential leap over just 90 days).

With that, we heard from Seagate today, one of the data storage kings.

Revenue was up 44% year-over-year to $3.1 billion. Record gross margins. Almost a billion dollars of free cash flow in a single quarter — the highest level Seagate has reported in over a decade.

But here was the bigger takeaway: Seagate told us that the top three global cloud providers have nearly doubled their remaining performance obligations to $1.1 trillion.

That’s the future revenue that enterprises and developers have already contractually committed to those cloud providers, primarily for AI infrastructure. And it’s that number that’s taking down Seagate’s storage capacity all the way through calendar 2027.

They are sold out.

Seagate’s CEO described what is happening as the “inference inflection.” He said compute infrastructure is shifting from periodic training to becoming engines that continuously generate mass capacity data.

Agentic AI is the new demand driver (continuously ingesting inputs, generating reasoning, and storing output). Physical AI will take it to yet another level. AI robots create massive amounts of data that needs to be stored, retained, and reused, making storage demand continuous.

So, this sets the stage for tomorrow. If the top three cloud customers have committed $1.1 trillion in future revenue and are scaling AI capex into the infrastructure that fulfills it, then Google, Amazon and Meta should be guiding higher on capex, not lower.

They should be confirming that AI demand is accelerating, not stabilizing.

This is the thesis we’ve been building our AI-Innovation Portfolio around since June 2023. Endless demand drives outsized value in the companies that provide the scarce infrastructure resources in this fourth industrial revolution. Join us here, or click below for more details on how we’re positioned and why.

In my last note, we walked through how the coming Fed regime change puts Europe under the gun.

We talked about how the screws turning on the ECB could be the catalyst for political change in Europe — and realignment with the United States, away from China, away from the “third pole” posturing.

Just days later, the European leadership is showing desperation.

France’s Macron flew to Beijing, spent six hours with Xi, and on the flight home told reporters that Europe should break from the United States, stop depending on the dollar, and become its own “third superpower.”

Marco Rubio responded by publicly stating that if Europe refuses to align with the U.S. on Taiwan, the U.S. will withdraw from Ukraine.

And then today, German Chancellor Merz went on camera and said the U.S. campaign in Iran is “ill-considered,” that the Americans have “no convincing strategy,” and that “an entire nation [the U.S.] is being humiliated.”  This is the same guy who, early last week, said “every man knows we cannot defend ourselves by our own strength.”

What’s going on?  

To answer that, let’s revisit an excerpt from a year ago (my May 7th, 2025 note) …

Pro Perspectives – May 7, 2025

“… restoring U.S. influence with Europe hasn’t worked.  The Trump efforts to end the Ukraine-Russia war have been met with pushback from Europe.

 

They’ve responded with the 800 billion euro plan to ‘re-arm’ Europe, in what seems to be an effort to support a continuation of the war. 

 

The trillion-dollar question is, who will fund it? 

 

Well, who’s looking for a new market to direct its excess manufacturing capacity toward, while also supplying the cheap credit to buy their stuff?

 

China. 

 

… with the U.S. looking to end the multi-decade wealth transfer to China, China may have a ‘plan B’ in Europe. 

 

Would the European Commission take the invitation to partake in China’s capacity dumping, credit fueling, industry gutting economic partnership? 

 

We may find out in the coming months.” 

With a liquidity crisis coming down the pike in Europe (accelerated by the energy shock), this time without the backstop of the world’s most powerful central bank (the Fed), the Brussels political class has only two paths.

Path 1) They can align with Washington, which would mean admitting that their policies — open borders, climate agenda, deindustrialization, energy dependence, dismantled defense capacity — destroyed Europe’s competitiveness.

If they do that, they relinquish their power grip, and likely end their political careers.

Path 2) They accept Chinese liquidity and solvency support in exchange for becoming the next debtor consumer market for Beijing.

Is the Macron trip and Merz rhetoric a clue on path 2 (at least trying to develop some negotiating leverage with Trump)? 

Trump’s strategy has seemingly been to squeeze them economically and financially (by the vulnerabilities of their own design) until the costs of the current leadership become unbearable, and the people of Europe deliver their own change of leadership.

That’s the political backdrop heading into two related central bank meetings this week.

The Fed meets Wednesday. This will be Jerome Powell’s last meeting as Fed Chair.

In the post-FOMC meeting press conference, will any of the esteemed financial media think to ask him about the nearly $200 billion of balance sheet expansion the Fed has done since December? Moreover, will anyone ask about Powell’s December declaration that ongoing $20-$25 billion a month would be needed indefinitely?

This, as the incoming Fed Chair (Warsh) just said last week that the Fed needs a smaller balance sheet. 

Then Thursday, we get the ECB.

Since the Iran strikes eight weeks ago, Europe’s rate picture has flipped. On Feb 27th, the market was pricing in a small chance of a rate cut, now it’s pricing in two rate hikes by year end.

But the ECB can’t resolve an energy-shock-driven inflation with rate hikes.

More likely, the energy shock comes with demand destruction, a slower economy, and harder times for the fiscally fragile countries in Europe. And with that, the ECB’s program that’s designed to defend the solvency of the fiscally fragile countries in Europe, will most likely be tested in the coming months.    

With a Trump-led Fed getting closer, let’s step through this framework we’ve been discussing all year — how the Fed plays into bringing Europe back into alignment with the U.S., and how the end game is isolating China.

In yesterday’s note, we talked about Kevin Warsh’s view on the Fed balance sheet — that it’s grown to the point where it’s become “fiscal policy in disguise,” and that it’s time for the Fed to get out of the fiscal business.

That’s regime change coming at the Fed.

And this should restore the important role of the market in disciplining the government’s tendency toward profligate spending. Market discipline means accountability, because market penalties mean higher rates (higher risk premiums).

So, as we discussed yesterday, this Fed regime change should bring fiscal discipline for the current and future governments (by design).

It should be good for the dollar, and dollar assets. 

And in the near term, it should clear the way for lower interest rates, because getting the Fed out of the government financing business should remove the structural reason rates are high (the fiscal profligacy premium).

With that, if we wonder where Warsh thinks rates should be, based on the economy, back in February, when he wasn’t holding anything back, he said “AI is going to make everything cost less,” and that “we are at the front end of a productivity boom.”

In fact, he said “we are probably in the early innings of a structural decline in prices.”

Now, this Fed regime change creates a serious problem for Europe.

We talked in our February 5 note (here) about how the Trump-led Fed exit from the QE era (and end to its role as the “global central banker to the world”) would put Europe under the gun.

Why? 

The ECB has been doing its own version of fiscal policy in disguise for the better part of a decade, buying the debt of fiscally vulnerable euro zone sovereigns to keep the doom loop from collapsing the entire system.

The difference is the Fed backstops the dollar, which is the world’s reserve currency. The ECB doesn’t have that privilege. And when the Fed steps back from its role as the implicit backstop of the global system, the ECB will be scrambling for the liquidity it needs to prevent its solvency problem from rearing its head.

The screws will be turning on the ECB.

And as we’ve discussed often in these notes, that reality could be the catalyst for political change in Europe — a populist shakeup, moving Europe back into alignment with the United States (away from China, away from the “third pole” posturing).

And then there’s China.

Today the White House and the House Select Committee on China moved in coordination to publicly frame Chinese AI model theft as a national security threat — and deployed the export controls against it.

Meanwhile the Wall Street Journal reports today that the Iran war has drawn down U.S. munitions stockpiles to the point where some officials are worried about a readiness for a different Strait — Taiwan.

As we’ve discussed, the ramp in the U.S. defense industrial base that’s been underway since early this year (to a planned 4 times the amount pre-Iran strikes) suggests that war capabilities are being sized for something bigger than Iran (i.e. China). The Pentagon announced Tuesday a $1.5 trillion budget request for 2027, the largest in U.S. history.

So, we have Fed reform coming at home. Dollar leverage over Europe. Industrial mobilization against China. All following the framework we’ve been discussing, and all in the same week.