Peak Nvidia, the big Fed debate, and bulging deficits

Nvidia shares slump despite chipmaker doubling revenues

Was that the top? Nvidia shares slumped 7% in after-hours trading despite doubling revenues. Sky-high expectations were not quite matched. Revenues rose 122% to $30bn, ahead of the $28.7bn anticipated by most analysts. But the deceleration in growth (from 262% in the prior quarter) did little to assuage investor fears that the best times are over. And CEO Jensen Huang didn’t really address delays in production of the new Blackwell chips.

The company now boasts “earnings watch parties” in bars — which gives the feeling like Nvidia stock is at its peak. The price of NVDA shares doesn’t tell you anything about the fundamentals of the business — I heard Warren Buffett say that once.

Shares in Europe were up a bit this morning despite the wobble this inevitably suggests. US stocks closed down on Wednesday, with the Nasdaq shedding 1.12% ahead of those earnings.

NDX futures gapped down but have since rallied back to where they were.

Also watch Amazon shares as they test their 200-day line.

Will the Fed cut by 25 or 50bps in September?

The key debate in market and economic circles right now is whether the Federal Reserve goes with a 50bps or 25bps cut in September. For the market, which is entering what’s usually its worst month and a likely volatile stretch into the election, it will matter a lot. Usually, a 50bps cut means serious economic weakness and poor forward returns. But maybe it will be different this time.

GDP figures today from the US expected at 2.8% for the second quarter — but this is old news, so not too telling for the Fed. Weekly unemployment claims figures are also due out and are much more important as the labour market is now everything.

The US10s2s yield spread has nearly uninverted, whilst the dollar may be bottoming with sentiment towards USD “max bearish.” Yesterday EURUSD retested 1.110 and held for the time being, but watching for a reversal in the big bull run on the MACD.

Carry on up the procyclical deleveraging

Leverage kills: at least usually we can link deleveraging to most recent market selloffs, including the flash crash of early August. The Bank for International Settlements (BIS) has outlined what it thinks happened, pointing to the seemingly innocuous jobs report from the US and a hawkish turn by the Bank of Japan, producing an unwinding of the popular yen carry trade, as unlikely catalysts for such a big move. Such a big move – the Topix fell 12% in a single day, is down to “amplifying factors”, most notably deleveraging pressures amid thin markets.

Here’s what the BIS summary said:

• Financial market volatility resurfaced in early August as the unwinding of leveraged trades in equity and currency markets amplified the initial reaction to a negative macro release in the United States. Markets then stabilised quickly, and volatility receded.
• FX carry trades were hit hard by the deleveraging pressures. Their overall size is difficult to measure. Various estimates based on both on- and off-balance sheet activity yield a rough middle ballpark of ¥40 trillion ($250 billion) going into the event, which, if anything, is biased down due to data gaps.
• The event was yet another example of volatility exacerbated by procyclical deleveraging and margin increases. Although an outright market dysfunction was averted this time, the structural features of the system underpinning such episodes deserve continued attention by policymakers.

Even crypto got swept up in the tsunami, which BIS thinks indicates retail traders faced margin calls and may have been forced to close positions even in seemingly unrelated assets.

The worry is that this is not going away. BIS notes that the actors behind the volatility spike and large market moves have not changed significantly.

“Risk-taking in financial markets remains elevated,” says the report, which points out that only a portion of various trades that relied on low volatility and cheap yen funding appear to have been unwound; some other trades may yet need to be unwound more slowly; and that there are already indications that some leveraged positions are quickly being rebuilt.

“More broadly, a number of factors behind the recent turbulence reflect structural features of our financial system, notably the greater heft of market-based finance,” warns BIS. “Of particular concern are the ones that enable the build-up of large positions in periods of calm and necessitate their quick unwinding when volatility rises. The reliance on leverage for many of these positions implies that investors will have to respond more strongly to adverse shocks to avoid significant losses. If such behaviour takes place in a jittery and illiquid market environment, volatility could be further exacerbated, and a negative feedback loop could be kindled. In addition, sudden (and large) changes in margins from derivatives and securities positions that are not directly linked to trades that rely on low volatility could add further pressure to markets, infrastructures and intermediaries.”

It’s not a bug, it’s in the code.

Budget black holes

The UK's ruling Labour Party has touted an unexpected £22 billion black hole in the nation’s finances as requiring some ‘painful’ measures at the upcoming Budget. But the UK is not alone. Italian PM Giorgia Meloni is said to be seeking to plug a €12bn budget black hole with cost cuts that may include a delay to the retirement age. Mamma mia!

The ruling alliance’s leaders meet on Friday as they return from their summer break with a pressing need to find €25bn for next year to plug the fiscal deficit – but only half is available, as per a Bloomberg report. Italy has until September 20th to put forward a budget plan to rein in its deficit that is some ways above the EU’s 3% limit.

Deficits don’t matter

...until they do. I discussed this with veteran economic commentator David Buik on our podcast, Overleveraged. There’s since been a lot more from the presidential candidates on the economy and tax. The noble folks at the Penn Wharton Budget Model have delved into what it all means for the US deficit. Debt servicing costs are already soaring – and it will get worse whoever wins in November.

Donald Trump has endorsed several tax-related policy proposals, such as extending the expiring provisions of the 2017 Tax Cuts and Jobs Act (TCJA) and recommends additional reductions in the corporate tax rate to 15 percent. Trump also favours eliminating income taxes on Social Security benefits.

The Penn folks reckon this would increase primary deficits by $5.8 trillion over the next 10 years on a conventional basis and by $4.1 trillion on a dynamic basis that includes economic feedback effects. GDP would rise a bit to start but eventually falls relative to current law, in their model, falling by 0.4 percent in 2034 and by 2.1 percent in 30 years. Low, middle, and high-income households in 2026 and 2034 all fare better.

Kamala Harris’ tax and spending proposals would increase primary deficits by $1.2 trillion over the next 10 years on a conventional basis and by $2.0 trillion on a dynamic basis that includes a reduction in economic activity, whilst GDP falls by 1.3 percent by 2034 and by 4 percent within 30 years.

We talk about Trump and Harris’ economic plans in today’s edition of Overleveraged.

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