Stocks After NVDA: Will Tariffs or the Fed Hit Markets Next?

Macro Money - Market Analysis: February 29, 2024

Key Concepts:

• Fed Watch: Monitoring expectations regarding Federal Reserve monetary policy (interest rate decisions).
• AIPA (American Import Duties Act): Legislation granting the President authority to impose tariffs. Its broad interpretation was deemed unconstitutional by the Supreme Court.
• PPI (Producer Price Index): A measure of wholesale inflation, tracking price changes from the perspective of domestic producers.
• Trade Policy Uncertainty Index: An index developed by Federal Reserve economists to gauge uncertainty surrounding trade policy based on news flow.
• Magnificent 7: A group of seven large-cap US technology companies (Nvidia being a key member) that have driven significant market gains.
• Risk Aversion: Investor tendency to shift away from riskier assets towards safer havens like the US dollar and bonds.
• Duration (in options trading): A measure of an option’s sensitivity to changes in interest rates. Higher duration means greater sensitivity.
• Delta (in options trading): A measure of how much an option’s price is expected to move with a $1 change in the underlying asset’s price.

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I. Market Overview & Initial Reactions to State of the Union & Nvidia Earnings

The trading week concluded with a period of “churn and indecision” following the State of the Union address and Nvidia’s earnings report. Initial reactions saw the dollar decline 0.5% – its largest drop in two weeks – after President Trump announced plans to reinstate tariffs previously struck down by the Supreme Court. However, this decline was largely reversed during the day, driven by risk aversion and the dollar’s role as a safe haven. The S&P 500 experienced a pullback after rallying in anticipation of Nvidia’s earnings.

II. Tariff Policy & Dollar Dynamics

President Trump’s intention to reimpose tariffs, circumventing Congressional authority through alternative statutes, created uncertainty. While the initial announcement weakened the dollar, the subsequent shift towards risk aversion bolstered it. The President’s approach requires demonstrating “abusive trading practices” or “unfair market access” by foreign entities, a more complex process than the previously contested interpretation of AIPA. The European Union has already paused its trade agreement with the US pending clarification of the new tariff policy, citing potential violations of the existing agreement (a 15% blanket rate for 150 days). Iljas Pivac noted, “This is a source of vast uncertainty as it is.”

III. Nvidia Earnings & Market Impact

Nvidia’s earnings significantly exceeded expectations, beating on EPS, revenue, and guidance for the next quarter. Specifically, Q1 2025 revenue is projected at $78 billion, a $10 billion increase from the previous quarter and surpassing the consensus estimate of $72 billion. Despite this positive report, Nvidia’s stock price fell sharply, dragging down the broader market. This downturn, coupled with the tariff uncertainty, fueled a flight to safety, benefiting the dollar and bonds. The market’s reaction suggests a narrative exhaustion around AI-related stocks, as highlighted by the decline in software names.

IV. Bond Market & Risk Aversion

Bonds rebounded sharply alongside the dollar, despite the typical inverse relationship between bond yields and dollar strength. This indicates a classic risk-off scenario where investors seek safety in US Treasury bonds, driving up prices and lowering yields. Pivac emphasized, “That is not a dollar being animated by positive risk sentiment. That is a dollar being animated by risk aversion.”

V. Upcoming PPI Report & Trade Services Component

The January PPI report is a key economic event, with expectations of a 2.6% year-on-year decline at the headline level and a 3% core reading. However, the critical component is the trade services component, specifically focusing on margins for intermediate and final demand. A sharp squeeze in margins has been observed at the beginning of 2025, with wholesalers absorbing tariff costs to avoid impacting consumer demand. The report’s implications hinge on whether this margin squeeze continues.

• Scenario 1: Continued Margin Squeeze: If margins remain compressed, businesses may seek to recoup costs once the Supreme Court ruling on AIPA-based tariffs is fully understood, potentially leading to inflationary pressures.
• Scenario 2: Margin Expansion: If margins expand, it could signal a pass-through of tariff savings to consumers, potentially dampening inflation.

The report is expected to reveal a surge in lawsuits (approaching 1,000) seeking reimbursement for tariffs previously deemed unconstitutional.

VI. Trade Policy Uncertainty Index & Market Sentiment

The Trade Policy Uncertainty Index, developed by Fed economists, demonstrates significantly higher volatility compared to previous periods of tariff implementation (even during the initial Trump administration and the onset of COVID-19). This heightened uncertainty is a primary driver of market demand for rate cuts, even though economic fundamentals remain relatively solid. Pivac stated, “This is why the markets want rate cuts. It's not necessarily because the economy is doing poorly.”

VII. GDP Growth & Fed Policy

While Q4 GDP growth fell short of expectations at 1.4% (compared to a 3% forecast), the Fed believes growth has exceeded expectations overall. The labor market remains “sticky,” with low hiring and firing rates, potentially driven by demographic factors. Despite this, the Fed remains hesitant to cut rates, citing the economy’s resilience. The market currently anticipates 52 basis points of rate cuts this year, double the Fed’s December projection. Recent comments from Fed officials, including Governor Chris Waller and Steven Mirren, suggest a more hawkish stance.

VIII. Portfolio Positioning (Ilas Pivac)

Pivac outlined his current portfolio positioning:

• Short Dollar/Aussie: Maintaining a small short position.
• Long Pound/Euro: Holding long positions.
• Long Gold: Remaining long on gold, with key levels holding.
• Short Risk Sentiment (Put Verticals): Utilizing put verticals on the NASDAQ (Q) and S&P 500 (SPY) with significant duration and diluted delta exposure.
• Long Crude Oil: Maintaining a long position, anticipating a structural advance.
• Long Brazilian Stocks: Benefiting from Brazil’s role as a key supplier to China.
• Put Option on Insurers: A speculative put option on insurers, anticipating potential impact from private credit concerns.

IX. Geopolitical Risks & Oil Prices

Geopolitical tensions, particularly in the Middle East (Venezuela, Russian shadow tankers, Iran), are driving up crude oil prices, potentially contributing to sustained inflationary pressures. The disruption to China’s oil supply, reliant on sanctioned crude, further exacerbates the situation. Pivac noted that it takes approximately a month for oil price movements to impact CPI.

Conclusion:

The market is navigating a complex landscape of tariff uncertainty, Nvidia’s earnings impact, and shifting Fed policy expectations. The upcoming PPI report will be crucial in assessing the extent of margin pressures and potential inflationary risks. The prevailing sentiment is one of risk aversion, driving demand for safe-haven assets like the dollar and bonds. The underlying driver for rate cut expectations appears to be a desire for a “backstop” against the numerous uncertainties facing the market, rather than a fundamental deterioration in economic conditions. The situation remains fluid, and continued monitoring of economic data and geopolitical developments is essential.