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US financial conditions hit March 2022 low; Nvidia chip demand explodes
Peter Garnry
Chief Investment Strategist
Résumé: The annual Jackson Hole symposium starts tomorrow and with the discussion heating up around whether the Fed has arrived at peak rates a lot is at stake. Some central bank watchers have suggested that the Fed might raise its long-term projection for the natural rate of interest rates which would be a signal to the market that rates will stay higher for longer and that peak rates have been reached yet. Nvidia's blowout earnings on explosive demand for its AI chips have lifted sentiment in equities.
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.
Nvidia earnings explode on gold rush among AI startups
Nvidia did better in FY24 Q2 (ending 31 July) than even the wildest imaginations on Wall Street reporting revenue of $13.5bn vs est. $11bn and raised their Q3 revenue guidance to $16bn +/-2% compared to estimates of $12.5bn. Shares rallied 7% in extended trading to new all-time highs. The chart below shows the realized revenue figures (dark blue) before yesterday’s earnings results including the estimated revenue figures (light blue) against the realized revenue figure in Q2 and Nvidia’s estimates for Q3 (orange bars). Other stocks that will benefit from Nvidia’s outlook and demand projections are TSMC, ASML, and AMD.
As we alluded to in yesterday’s equity note Who is buying Nvidia’s AI chips? the capital expenditures of large US and Chinese technology companies do add up to the demand explosion that Nvidia has realized and estimates will continue in Q3. TSMC which is one of Nvidia’s largest contract manufacturers have reported three consecutive quarters of negative revenue growth q/q with Q2 revenue figures in USD down 10% y/y. Seen in that light, Nvidia’s figures were astonishing. They point to two likely underlying drivers. First, the mix of capital expenditures on technology have shifted in favour of AI-focused chips and secondly, the long tail of AI startups in the generative AI segment are driving an almost panickily behaviour in a drive to be first. As the data from CB Insights suggests, venture capital funding is up more than 6x year-to-date compared to all of 2022. Total funding for generative AI could reach $30bn this year alone. That is a lot of extra demand flowing towards Nvidia as these startups are part of a grand gold rush.