You don’t have to buy OpenAI or Anthropic to invest in AI. Each large language model requires specialized technology to keep running and growing.

MarketBeat’s The Infrastructure’s Backbone: 10 Stocks Powering the AI Buildout report reveals 10 companies supplying the memory, storage, connectivity, fabrication, power, and cooling behind AI’s next phase.

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When you look at the four economic developments:

When you look at these, they create a big picture.

Together, they may explain why long-term interest rates have remained elevated even when inflation has come down in the last 5 years from its peak of 9.1% in 2022.

For more than a decade, following the 2008 financial crisis, the Federal Reserve purchased large amounts of Treasury securities and mortgage-backed securities through Quantitative Easing.

The goal was simple and straightforward. Lower long-term interest rates and encourage borrowing by supporting investment. Liquidity is increased throughout the financial system when the Federal Reserve buys large amounts of Treasury securities. This increases demand for securities. Greater demand generally creates higher bond prices and lower yields.

Today this environment has changed. The Federal Reserve is no longer expanding its balance sheet the way it did in the past. No, instead markets are increasingly determining interest rates on their own, without the central bank’s support.

This doesn't necessarily mean higher rates forever. It means one of the largest buyers has stepped back, that’s all.

Many business owners have felt this change through things like equipment loans costing more, commercial real estate loans costing more, and business lines of credit, you guest it, costing more. Even customers, who finance purchases, think twice before spending more.

Unfortunately, higher interest rates don't just affect borrowers. They affect hiring decisions, expansion plans, commercial construction, housing, and consumer spending. Money is still moving through the economy, but it may just move a little slower.

One thing we need to look at is how much money big tech is investing in artificial intelligence. We’re of course talking about Microsoft, Alphabet, Amazon, Meta Platforms, and a few others who are collectively planning to beg, borrow, and spend hundreds of billions of dollars for their AI infrastructure.

This includes:

Some of that investment comes from cash already in their pockets, and believe it or not, some comes from issuing new debt. Don’t believe everything you hear from your local protest. It’s not like it was a few years ago. Many of these companies are no longer simply accumulating enormous cash reserves. They are spending capital at an unprecedented amount.

We and they don’t really know if AI is ultimately going to produce returns that justify these investments. But one thing seems to be clear. Large-scale investment, of this kind, requires a whole lot of capital, and it ain’t cheap!

Japan has long been one of the largest foreign holders of U.S. Treasury securities. Believe it or not, for decades Japanese investors have helped finance U.S. government borrowing while also seeking relatively safe investments.

However, times are changing. Japan's own economy is changing. The Bank of Japan is having to move away from years of ultra-low interest rates. 

If Japanese yields become more attractive at home, or if Japanese authorities need to support the yen, some investors could choose to bring capital back to Japan or reduce purchases of U.S. Treasuries.

This doesn't necessarily mean Japan will become a major seller of Treasury securities. But even modest changes in buying behavior from one of the world's largest investors may influence financial markets in the United States.

You might have guest, opinions differ. Some economists believe inflation remains the primary driver of long-term interest rates. After all, it's the easiest explanation.

Other economists will tell you government deficits are becoming more important. Then some others will say, including James E. Thorne, changing global investments and expenditures deserve far more attention than they’re receiving.

The truth is it’s probably a little bit of each of them put together. As I said before I’m not an economist. All I know is It’s probably more complicated than any single one explanation. Because, as history has taught us, financial markets rarely move because of one event. They usually reflect different decisions made by governments and investors over time.

With that said, I do think the decisions of the Japanese government, regarding the U.S. Treasury Bond investments, Big Tech investment/debt, and the end of Quantitative Easing as we know it, will make a dent in our economy. How big a dent, who knows?

Higher interest rates don't necessarily mean lower stock prices. History shows that strong corporate earnings can support stock prices even during periods of higher interest rates.

However, higher interest rates on lending can reduce corporate profits and reduce capital expenditures, of course, and increase the prices of things. Also causing consumers to make different purchasing decisions, which could lead to investors valuing future earnings differently. 

We know that the 10 Year Treasury yield is tied to the mortgage rate because even though the average home mortgage in the U.S. is a thirty year mortgage, the average amount of time a home owner holds a mortgage in the U.S. is around 10 years. So if the change in Japanese purchases of U.S. Treasury Bonds affect the 10 Year Treasury yield, it will probably have an effect on the mortgage rate.

To find out how many U.S. Treasury securities the Japanese government is holding or selling you can look at the Treasury International Capital (TIC) System and Major Foreign Holders of U.S. Treasury Securities (Table 5) .

We all know that bond rates usually affect the stock market inversely. If Big Tech does start pulling their money out of the stock market, to fund AI expenditures, it will probably affect the volume of stock in the market, which will have an impact. One way to see if this is happening is to look at the 6 month VIX index. 

Also, how will weaning the market off of that Quantitative Easing money affect it? You can find out if Quantitative Easing is going up or down by looking at if the Federal Reserve Balance Sheet is increasing or decreasing. 

These are a few things to keep an eye on.

Don’t go chicken little on me now. Rather than trying to predict where the stock market is headed next month, focus on the financial decisions you can control by doing things like: 

Those habits tend to remain valuable regardless of what the economy does next.

One mistake not to make is allowing every headline to drive decisions. Financial news is designed to capture attention. Good business planning should be based on 90% of your personal microeconomics. Ok, I can’t back up the 90%, but it should be based on a lot.

When reading financial news or any news for that matter, compare multiple sources. Understanding the motivation behind different viewpoints. This often produces better decisions than reacting to a single headline.

The reason I found James E. Thorne's post interesting, was because it encouraged me to ask more intelligent questions. For instance, could several global economic changes be interacting and affecting the U.S. economy in ways that aren't immediately obvious? 

As business owners, we don't have to predict every economic shift correctly. But we will benefit from understanding the forces that may influence borrowing costs, investment decisions, customer behavior, and financial planning.

Curiosity usually leads to creativity which leads to unique opportunities and solutions. Asking better questions is the key to success and prosperity.

Whether you're preparing for tax season, trying to build stronger financial systems through repeatable systems, or simply want books that help you make better business decisions throughout the year, The Smith Advisory is here to help. Our goal is to help business owners maintain tax-ready books, understand the financial information, and create repeatable financial systems that make sense.

If you'd like to start a conversation, email [email protected]. A small improvement in your financial systems today can prevent much larger problems tomorrow.

This newsletter is provided for educational and informational purposes only. The economic topics discussed are based on publicly available information and represent a summary of current research and differing viewpoints among economists. References to James E. Thorne's commentary are included because they inspired the questions explored in this article, not because they establish economic fact. I am not an economist, financial advisor, or investment adviser, and nothing in this newsletter should be construed as investment, legal, tax, or financial advice. Every business owner's circumstances are different. Before making investment or financial decisions, consult with qualified professionals regarding your individual situation.