As inflation data continues to cool, market expectations for a September rate hike by the Federal Reserve are rapidly diminishing. Jeremy Siegel, Senior Economist at WisdomTree and a Finance Professor at the Wharton School, suggests that if oil prices remain near $80 per barrel, the Fed is likely to hold off on a rate hike in September. Meanwhile, U.S. stocks have extended their rally, with the S&P 500 index breaching 7,800 points for the first time, and the bond market has also seen a notable rebound. The market is reassessing a key question: with employment weakening and inflation cooling, does the Fed still need to continue tightening policy?
Cooling CPI and PPI Reduce Urgency for Rate Hikes
U.S. economic data released this week has provided significant support for the "pause rate hikes" camp. The July CPI rose by 0.1% month-over-month, with the annual rate dropping from 3.5% in June to 3.4%. Subsequently, the PPI also came in weaker than expected, further indicating that the inflationary pressures from the earlier oil price shock are easing. Siegel stated that two consecutive months of relatively mild inflation data have significantly reduced the need for a September rate hike. He also noted that Goldman Sachs, following the latest data, has lowered its forecast for the Fed's preferred PCE price index, now expecting a monthly increase of only 0.2%.
The unexpected cooling in the labor market has further altered market perceptions. Last week's July employment data showed an unexpected decline in U.S. job numbers, prompting traders to scale back their bets on a rate hike within the year. Oil prices have become another critical variable. Since the supply shock from the U.S. strikes on Iran, energy prices have been a major factor pushing up U.S. inflation and long-term Treasury yields. However, oil prices have fallen sharply this week, with U.S. benchmark crude dropping more than 3.5% at one point on Thursday, further alleviating concerns about a resurgence in inflation. Siegel therefore offered a fairly clear assessment: as long as oil prices can stabilize around $80, the likelihood of a Fed rate hike in September will significantly decrease. Current market pricing suggests the probability of a September hike has fallen below 40%. Previously, the market had fully priced in at least one rate hike by the Fed this year.
Bond Market Rebounds, but Long-Term Debt Still Under Fiscal Pressure
The impact of cooling inflation on interest rate expectations has quickly transmitted to the U.S. Treasury market. On Thursday, Treasury yields broadly declined, with some maturities falling by as much as 6 basis points at one point. Short-term bonds were particularly supported, as they are most sensitive to changes in Fed policy. However, the long end of the market has not fully escaped pressure. The U.S. Treasury auctioned $25 billion in 30-year bonds on Thursday, with the final high yield reaching 5.216%, marking the highest borrowing cost for a 30-year bond auction since 2001. In other words, while the market is beginning to believe the Fed may not need to continue raising rates, it does not mean long-term Treasuries have fully shed their pressure. High fiscal deficits, substantial borrowing needs, and long-term inflation risks are still elevating the returns investors demand for holding long-term government bonds.
John Briggs, Head of U.S. Interest Rate Strategy at Natixis, also cautioned that the recent bond market rally has already partially priced in the possibility of a moderate PCE data release, making further gains more difficult. A bigger risk looms from the late August Jackson Hole symposium. Fed Chair Warsh has previously emphasized controlling inflation but has not clearly signaled September policy. Briggs believes Warsh's speech at Jackson Hole could serve as an opportunity for "hawkish communication" to solidify his anti-inflation credibility. Therefore, the bond market currently faces a delicate situation: short-term data supports rate cuts or at least a pause in hikes, but the Fed may still use hawkish rhetoric to suppress overly accommodative market expectations.
U.S. Stocks Hit New Highs, Market Bets on 'Soft Landing'
Similar to the bond market, U.S. stocks are also repricing the path of interest rates. The S&P 500 index broke through 7,800 points for the first time, with corporate earnings growth and cooling inflation jointly driving a rise in market risk appetite this month. Siegel believes the current market optimism is not "excessive." He is particularly bullish on the earnings expansion driven by AI. In the past, the market mainly focused on AI infrastructure giants like Microsoft (MSFT.O) and Nvidia (NVDA.O), but Siegel argues that AI is gradually spreading to more traditional industries, allowing companies to reduce costs and increase profit margins through AI. Meanwhile, capital is rotating from expensive growth stocks to lower-valued value stocks. Some companies trading at around 15 times earnings have not yet fully reflected the efficiency gains from AI, leaving room for earnings improvement. Siegel even suggested that the recent leverage-driven liquidity panic in the market was more of a risk release event than a more serious systemic problem. As risks are digested and economic data continues to cool, U.S. stocks have once again reached new all-time highs.
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