CEO House View | Solid Foundations, Shifting Signals: Why Liquidity Still Supports Markets as AI Earnings Enter a New Phase

💡MacroMicro believes no further Fed rate hikes are likely this year because the Federal Reserve left interest rates unchanged in July despite a brief rise in implied probability, and monthly Core PCE inflation came in at 0.19%, below John Williams' 0.2% threshold. Additionally, the New York Fed's Reserve Management Purchases (RMPs) remained stable at $10 billion per month, indicating sufficient market liquidity.

💡Monthly Core PCE inflation influences the Federal Reserve's rate hike decisions by acting as a key indicator for inflationary pressures. For instance, when monthly Core PCE inflation registered 0.19% in July, falling below the 0.2% threshold highlighted by John Williams, it contributed to the Federal Reserve's decision to leave interest rates unchanged, reinforcing the view that no further rate hikes would occur in the second half of the year.

💡The impact of recovering Middle East crude exports on liquidity conditions is positive, as increased supply can lead to lower energy prices, which in turn helps keep monthly inflation below the 0.2% threshold. This recovery, observed during June and July, coupled with a rising Trump Pressure Index suggesting a low probability of full-scale conflict escalation, supports the expectation of relatively favorable liquidity conditions in the second half of the year if tensions ease in early August.

💡Taiwan's export and economic growth forecasts have been revised upward after TSMC's earnings conference. The forecast for export growth was increased from 11.6% to 12.8%, indicating a more robust outlook for Taiwan's trade performance. This revision suggests that the macroeconomic backdrop and Taiwan's fundamental economic conditions remain solid, despite some emerging concerns from corporate earnings reports.

💡Upstream inventories continue to rise in the semiconductor industry as companies prepare for the peak season and an active inventory restocking phase from the first half of the year through the third quarter. This accumulation is driven by robust AI demand for supply-constrained components, or "shortage materials," leading to a simultaneous rise in both revenue and inventory levels across the upstream supply chain, including ASICs, thermal solutions, optical communications, and server assemblers.

💡Significant changes observed in midstream capital expenditures and cash flow include an expansion of capital expenditure plans to their limits, accompanied by a noticeably less positive market response, and a marked deterioration in internally generated cash flow, with some companies experiencing rare negative readings. This has raised concerns about growing funding pressures and weaker cash generation among major midstream companies investing in AI data centers.

💡The two possible scenarios for AI adoption and its impact on capital expenditure are a base-case scenario (70% probability) where AI adoption at the application layer continues to expand, major midstream companies address funding needs through debt issuance, and internally generated earnings ultimately reverse cash flow pressures. The bearish scenario (15%-30% probability) anticipates capital expenditure growth slowing next year, weighing on the manufacturing cycle from late this year through the first half of next year due to deteriorating cash flow among major technology companies.

💡MacroMicro's base-case scenario, with a 70% probability, regarding AI adoption and funding for major midstream companies is that AI adoption at the application layer continues to expand. Major midstream companies will temporarily address funding needs through debt issuance and financing, with AAA borrowing costs of roughly 5% to 5.5% remaining reasonable. Google's shareholder cash flow, including financing activities, is expected to remain positive, with internally generated earnings ultimately reversing current cash flow pressures over the medium to long term.

💡During the third quarter, non-technology sectors recommended for investment diversification include financials and domestic demand-related industries. These sectors have the potential to provide an additional source of market support, offering investors an opportunity to gradually diversify beyond technology after an extended period of concentrated positioning, especially as current equity market pullbacks approach oversold territory and the economy remains fundamentally healthy.

💡MacroMicro will monitor three key indicators to assess market conditions going forward: first, revenue growth continues to outpace inventory growth, confirming the manufacturing cycle remains in an expansionary phase; second, Taiwan's export growth remains above 30%; and third, crude oil prices, as these factors provide insights into liquidity, macroeconomic health, and the ongoing manufacturing cycle.