Microsoft Reignites AI Trade as Fed Keeps Hike Risk Alive

Markets moved through the week with a sharp midweek scare and a powerful Thursday rebound, as investors balanced a divided Federal Reserve, cooler June inflation data, renewed Iran-related energy risk, and a heavy slate of mega-cap earnings. The major indices are set to end a volatile week slightly positive.

The biggest policy event was the July FOMC meeting. The Fed held the target range for the federal funds rate at 3.50% to 3.75%, but the vote was divided, with three policymakers preferring a 25-basis-point hike. The statement acknowledged that economic activity is still expanding at a solid pace, while inflation remains above the Fed’s 2% goal. Chair Kevin Warsh’s press conference did not deliver a clear roadmap, but the tone remained hawkish enough to keep rate-hike risk alive. Futures briefly priced an 80% chance of a September hike before easing to about 65% early Friday, while markets priced roughly 35 basis points of hikes by year-end.

Economic Data Was Mixed

The advance estimate of second-quarter GDP showed real growth of 1.5%, below the pace economists had expected and down from 2.1% in the first quarter. The headline miss reflected a widening trade deficit and inventory drawdowns, but domestic demand looked stronger beneath the surface. Consumer spending rose at a 3.2% annualized pace, and business equipment investment climbed at a 15.2% rate, reinforcing the idea that AI related infrastructure spending continues to support the economy even as headline growth cools.

June PCE inflation gave markets some relief, but not enough to settle the Fed debate. Headline PCE fell 0.1% month over month and cooled to 3.7% year over year, matching expectations. Core PCE rose only 0.1% for the month, cooler than the 0.2% estimate, while the year-over-year core rate eased to 3.3%, in line with expectations and down from 3.4% in May. The problem is that the moderation partly reflected lower energy prices during the temporary U.S.-Iran ceasefire, while renewed Middle East hostilities have since pushed energy risk back into the inflation outlook.

Mega-cap Earnings Were the Dominant Equity Catalyst

Microsoft (MSFT) delivered the week’s biggest positive surprise, with Azure growth and strong free-cash-flow commentary convincing investors that AI spending is translating into real returns. The stock’s post-earnings rally helped revive the AI trade and supported broader sentiment. Meta Platforms (META) delivered strong revenue, but the stock reaction was more complicated. Investors focused on heavy AI infrastructure spending and whether future monetization can justify the company’s elevated capex path. The reaction showed that markets are willing to reward AI spending only when the return on invested capital looks increasingly visible. Amazon (AMZN) helped restore confidence after Thursday’s close, with strong AWS and advertising trends offsetting concerns about higher capital spending and negative free cash flow. Apple (AAPL), by contrast, beat revenue and profit expectations, helped by strong iPhone and Mac sales, but traded lower after its September-quarter sales forecast was below Wall Street targets. Chief Executive Tim Cook cited advanced chipmaking supply constraints, while Apple said it is evaluating alternative memory-chip suppliers. Services revenue also missed estimates, adding to investor concern that the earnings beat may not fully carry into the next quarter.

Geopolitics Remained a Major Overhang

U.S.-Iran hostilities resumed, keeping oil markets volatile and forcing investors to consider whether energy inflation could reappear in the Fed’s language. Oil eased late in the week, but the conflict remains central to inflation expectations, Treasury yields, and risk appetite. Overall, the week showed a market that is still resilient but increasingly selective. The Dow and S&P 500 are modestly higher, while the Nasdaq-100 lagged as investors separated AI winners from companies facing capex, cash-flow, or guidance concerns. Microsoft proved that disciplined AI spending can lift the tape, but market now demands clearer evidence that mega-cap AI investment will translate into durable earnings in the foreseeable future.

Economic Calendar for Monday, August 3, 2026 (ET):

• 09:45 AM: S&P Global Manufacturing PMI Final (Jul)
• 10:00 AM: ISM Manufacturing PMI (Jul)
• 11:30 AM: 3-and 6-Month Bill auction

Earnings Monday:

• Premarket: Canaan (CAN), CNH Industrial (CNH), Loews (L), Marriott International (MAR), Sally Beauty Holdings (SBH), Sportradar Group (SRAD), Tyson Foods (TSN)
• Postmarket: BWX Technologies (BWXT), Cabot (CBT), Clorox (CLX), Diamondback Energy (FANG), Jazz Pharmaceuticals (JAZZ), ONEOK (OKE), ON Semiconductor (ON), Palantir Technologies (PLTR), SBA Communications (SBAC), Paymentus Holdings (PAY), Snap (SNAP), TKO Group Holdings (TKO), Vertex Pharmaceuticals (VRTX), Vornado Realty Trust (VNO), Whirlpool (WHR), Williams Companies (WMB)

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