US financial conditions hit March 2022 low; Nvidia chip demand explodes

Key points in this equity note:

• The Jackson Hole symposium starts tomorrow which will focus a lot on the changing global economy under the new geopolitical forces and potential changes to the estimated natural rate of interest rate (R-star). Despite the Fed’s attempt to tighten financial conditions to slow down inflation, US financial conditions remain the loosest since March 2022.
  
  
• Nvidia blasted estimates in Q2 and lifted its Q3 revenue outlook significantly above consensus estimates. Nvidia shares rallied 7% in extended trading.
  
  
• Nvidia’s strong demand are likely driven by two forces. A big shift in the technology capital expenditures mix towards AI chips and then a tidal wave of AI startups rushing to get AI chips to win this future industry.

Peak rates will be the big topic around the upcoming Jackson Hole

The Jackson Hole Economic Symposium starts tomorrow under the title “Structural Shifts in the Global Economy” which will undoubtedly concentrate around the fragmenting world order with the BRICS countries today announcing the inclusion of Saudi Arabia, Iran, and UAE. Other topics such as the natural interest rate (R-star), which is a central bank concept defining the equilibrium rate consistent with growth and stable inflation around the 2% target, will also be discussed as some central bank watchers have been suggesting that the Fed might lift their long-term projections for the US policy rate amid a potential change in their view on structural inflation dynamics and productivity.

The market is betting on peak rates and confirmation of that at the Jackson Hole symposium with the market pricing in four rate cuts by the December 2024 meeting. As monetary policy functions with a lag into the economy this might turned out to be the right prediction, but on the other hand, it is worth noting that US financial conditions (see chart), measured by the Fed’s own research on the topic, are the loosest they have been since March 2022 before the Fed accelerated their tightening cycle. In other words, despite unprecedented tightening in the short end of the yield curve financial conditions are still not tight. They are tighter compared to 2020 and 2021 but in a broader historical context they are not tight. This fact runs counter to the market’s conviction of peak rates, and with the recent breakout higher in the long end of the US yield curve a lot is at stake for markets going into the Jackson Hole symposium.

For now equities are excited about obesity drugs and AI chips holding up the market, but if the Fed sends a strong signal that peak rates might not have been reached yet then sentiment could quickly change next week.