US retail sales, often called the "terrifying data," fell sharply below market expectations, significantly cooling financial market bets on a Federal Reserve rate hike before early 2027. This dovish shift, driven by the data, is adding fuel to the ongoing AI-driven bull market, which has been powered by recent global semiconductor rebounds.
The latest set of US economic indicators has clearly tilted the Fed's policy balance from "must resume rate hikes as soon as possible" toward "maintain the status quo (keep rates unchanged)." The Fed now faces not an "overheated demand plus accelerating inflation" scenario, but rather inflation that remains above target yet marginally cooling, alongside consumer spending and employment beginning to lose momentum.
US retail sales in July unexpectedly recorded their largest decline in over a year, highlighting a slowdown in consumer spending at online stores and auto dealerships. Data from the US Census Bureau on Friday showed that unadjusted retail purchases fell 0.6% month-over-month, the steepest drop since May 2025, well below the consensus estimate of a 0.1% increase and a sharp decline from the previous month's 0.2% rise. Excluding autos and gasoline, retail sales fell 0.2%.
"Following strong consumer spending in the second quarter, retail sales eased in July, with the control group—a key component directly factored into GDP—showing unexpected weakness. The pullback in spending from Amazon's Prime Day event in June amplified the decline, but restaurant sales, a key indicator of discretionary spending, remained stable," said Andrew Sacher, senior economist at Bloomberg Economics.
Given that consumption accounts for roughly 70% of US GDP, retail sales data provides crucial guidance for investors assessing the US economic outlook and monetary policy trajectory. The data is dubbed "terrifying" because its significant impact on macroeconomic expectations and Fed policy often triggers sharp volatility in financial markets, including equities.
Consumer Spending Slams the Brakes
This retail sales report indicates that after relatively robust consumption in the first half of 2026, consumers temporarily slowed their spending last month. However, some analysts caution that the data may have been distorted by earlier spending shifts, notably Amazon's decision to move its Prime Day sales event from July to June this year.
As shown in the chart, the decline was led by a 2.2% drop in sales at non-store retailers like Amazon, the steepest since early 2025. Sales at auto and parts dealers fell 1.8%. Meanwhile, restaurant and bar revenue rose 0.5%, the only service-sector category included in the report. The so-called "control-group sales," which feed into the government's calculation of goods consumption in GDP, fell 0.4%, the largest decline since early 2025. This metric excludes food services, auto dealers, building material stores, and gas stations.
Economists remain cautious about future consumer spending, following large tax refunds that boosted spending earlier in 2026 and after the personal savings rate fell to a four-year low in June. Independent card spending data from Bank of America and PNC Financial Services Group Inc. suggests that spending growth slowed overall in July, following a boost from Amazon's Prime Day and the World Cup in June. However, a study by Bank of America's research institute indicates that consumers' overall financial health appears solid, with independently compiled savings levels still above pre-pandemic levels and the proportion of households paying off credit card bills in full is rising.
Four-Pronged Attack on Hawkish Stance
The combination of CPI, PPI, nonfarm payrolls, and retail sales data has dealt a significant blow to the Fed's hawkish stance. Interest rate futures market pricing now shows the probability of a Fed rate hike in September falling below 30%, a sharp drop from over 50% before the CPI data was released. The latest data set has clearly shifted the policy balance from "must resume rate hikes quickly" to "the Fed can afford to wait."
The July retail sales decline of 0.6% month-over-month, far worse than the expected +0.1%, and the control group sales drop of 0.4% against an expected 0.3% increase, combined with the July nonfarm payrolls decline of 23,000, a CPI increase of only 0.1% month-over-month, core CPI of 0.2%, and zero PPI growth. This combination of "cooling demand, stable employment, and no re-acceleration of inflation" has directly undermined the urgency of hawkish policymakers like Cleveland Fed President Beth Hammack, who have recently argued for "immediate action."
About five minutes after the retail data release, federal funds futures pricing showed a 70.4% probability of rates staying at 3.50%–3.75% in September, with only a 29.6% chance of a 25-basis-point hike. A week earlier, hawkish expectations for a hike were still above 50%. However, for December, the market sees a 38.1% probability of no change and a 44.0% chance of at least one hike, indicating significant divergence on whether the Fed will hike at least once this year or remain on hold.
The latest retail data also strengthens the argument made by Goldman Sachs senior economist Matheus Dibo, who predicts the Fed will hold rates steady all year. The key, Dibo suggests, is not that inflation has returned to 2%, but whether previous supply shocks from oil prices and tariffs have created genuine "second-round effects." Dibo believes housing inflation has room to fall further, the labor market is not overheated, and a wage-price spiral has not formed, giving the Fed time to wait for more data. The latest CPI and PPI data reinforce this view. Notably, this is not a completely isolated view from Goldman Sachs—a Bloomberg Intelligence survey of economists found the median forecast is for the Fed to keep rates unchanged for the remainder of 2026. In contrast, the three FOMC voters who advocated for a 25-basis-point hike in July—Hammack, Kashkari, and Logan—still believe policy is not restrictive enough and that action should be taken now.
"Bad News" Fuels the AI Bull Market
For the recent "AI super bull market" storming through stock markets, this retail data has added fresh fuel. However, the impact is primarily on the "valuation and liquidity" side—the denominator side of the DCF valuation model—rather than the earnings numerator. It does not prove that AI demand itself has suddenly become stronger, but it helps construct the "soft but not recessionary" macroeconomic environment that stock markets favor most.
US economic data, including inflation, nonfarm payrolls, and retail sales, is gradually becoming a "valuation catalyst" for the AI bull market. As long as a cooling in consumption does not devolve into a recession and oil prices do not re-ignite inflation, the Fed's continued inaction may be the most ideal macro environment for AI assets. If the economy merely transitions from overheating to moderate growth, and the Fed does not need to raise the risk-free rate further, then the discount rate and financing cost risk premiums for AI compute infrastructure stocks and the semiconductor sector—assets with very long duration and heavy capital expenditure—will decline. The expected trajectory of AI CapEx for Hyperscalers, along with deployments of GPUs, ASICs, HBM, DRAM, NAND, and data center optical interconnect infrastructure, are strongly driven by structural AI compute investment.
Therefore, the "soft but not recessionary" macro environment is a major positive catalyst for AI compute infrastructure stocks and the semiconductor sector, arguably second only to actual AI compute demand. The Philadelphia Semiconductor Index, which plunged nearly 29% from its June 22 all-time high to its July 29 low, had rebounded about 20% from that low by August 13. This suggests the July sell-off was more of an "AI crowded-position and extreme leverage liquidation storm" rather than a reversal of the strong fundamental earnings trend in the AI compute industry. South Korea's KOSPI, a bellwether for AI compute investment, rebounded from 5,593.56 points on July 30 to 6,977.94 points on August 14, a cumulative gain of about 24.7%, surging 11.5% this week alone. Samsung Electronics and SK Hynix saw weekly gains of 19% and 16%, respectively, with foreign capital flowing back in significantly over the week.
In other words, after recent industrial chain data showed that the AI compute fundamentals have not collapsed and are actually strengthening, the current investment phase is adding a new valuation catalyst: "reduced risk of Fed rate hikes." This creates a double boost from upward earnings revisions and easing interest rate pressure. CPI, PPI, nonfarm payrolls, and retail sales have collectively reduced the "right-tail risk" of rates. Strong semiconductor earnings and robust AI compute demand from the industrial chain are strengthening the fundamental base. As a result, previously underweight capital is being forced to chase the market again.
This explains why the current stock market rally is increasingly centered on "FOMO and re-leveraging" around the AI bull market, rather than being a cheap contrarian trade. Data from Citadel Securities shows that S&P 500 call option volume hit a record high on August 4, nearly double the daily average of the past year and about 10% higher than the previous record. The five-day period from July 30 to August 5 marked the largest five-day call option volume ever. Additionally, about 35% of S&P 500 components have seen a three-month call skew inversion, meaning investors are actively paying a premium to hedge against the risk of being left behind.
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