CEO House View | Geopolitics Fade, Fed Reforms: A Bull Market Backed by Fundamentals

💡Kevin Warsh's leadership will overhaul the Federal Reserve's policy framework by abandoning forward guidance, as evidenced by a dramatically shortened post-meeting statement of 130 words and his refusal to submit a dot plot or answer future policy path questions. The new framework will be characterized by fewer words, greater flexibility, fewer commitments, and greater policy discretion, returning the focus to the dual mandate of inflation and employment, reflecting a shift towards data dependence.

💡MacroMicro believes the Federal Reserve has little need for further tightening in the second half of the year because the US-Iran conflict has subsided, leading to inflation likely peaking in May. Core PCE is 3.3%, aligning with the Fed's year-end forecast, and the trimmed mean inflation measure is subdued at 2.3%. Furthermore, labor market conditions remain balanced, with the job openings to unemployed persons ratio near 1, suggesting no wage-driven inflation pressures like those seen in 2019 or 2023.

💡The Federal Reserve's dual mandate under Warsh's new framework emphasizes inflation and employment, aligning with a return to data dependence. Warsh's approach involves fewer words and greater policy discretion, moving away from forward guidance. Investors should assess the policy path by focusing on these two key indicators, as the de-escalation of US-Iran tensions has removed inflation as a major uncertainty, allowing the Fed to prioritize its core mandates.

💡The trimmed mean inflation measure, referenced by Warsh during his confirmation hearings, indicates that current price pressures remain subdued at 2.3%. This suggests that the inflation metrics Warsh focuses on are not as elevated as some market participants might assume. This lower figure, compared to the Core PCE at 3.3%, supports the view that underlying inflation is less severe, reducing the immediate pressure for the Federal Reserve to tighten monetary policy.

💡The strength of the current AI supply chain expansion is supported by several pieces of evidence, including rising enterprise adoption of AI applications, continued upward revisions to annualized revenues among leading large language model providers, increasing capital expenditures by major cloud service providers (CSPs), and improving average revenue growth rates across the broader supply chain. Notably, Taiwan's exports reached US$78.4 billion in May, exceeding the US$70 billion threshold and leading to revised higher economic growth outlooks.

💡The manufacturing sector is currently in the Active Restocking phase of the classic inventory cycle: Passive Destocking → Active Restocking → Passive Restocking → Active Destocking. In this stage, companies are intentionally building inventories in anticipation of continued strong orders, rather than due to weakening demand. Evidence includes new orders growing faster than customer inventories, expanding profit margins, and NVIDIA's inventory increase concentrated in raw materials and work-in-progress.

💡When new orders remain stronger than customer inventories, rising inventories should be interpreted as a byproduct of economic expansion rather than a warning signal. This indicates that companies are proactively building up stock in anticipation of continued robust demand. For example, NVIDIA's inventory increase is concentrated in raw materials and work-in-progress, reflecting preparation for strong demand, not weakening end-market consumption. The "Orders minus Inventories" measure remains positive in this scenario.

💡The true inflection point for inventory dynamics in the manufacturing cycle will occur when inventories continue rising while order growth begins to weaken. This will signal a transition from the current Active Restocking phase into the Passive Restocking stage. This shift from late Q3 into Q4 will be the most important economic indicator to monitor monthly, as it would suggest a change from expansion-driven inventory building to accumulation due to slowing demand.

💡Q3 is considered a safe zone for equity markets because inflation has likely peaked, labor market conditions remain balanced, and there are virtually no conditions under Warsh's reform framework that would compel the Federal Reserve to raise rates. The US-Iran ceasefire removed oil-related risk premiums, and the manufacturing cycle remains firmly in expansion. Consequently, any valuation-driven pullback during Q3 should be viewed as a buying opportunity, with equities expected to outperform bonds.

💡Three indicators will be critical for assessing the manufacturing supercycle in Q4 as markets price 2027 conditions. First, major cloud service providers must raise projected capital expenditures to US$1 trillion next year, from current expectations of approximately US$850 billion. Second, Taiwan's exports need to advance from the current US$70 billion range towards US$100 billion per month to sustain high growth rates given higher base effects. Third, the New Orders-to-Customer Inventories ratio must remain positive, avoiding a passive restocking phase.