Major US stock indexes showed mixed performance this week, with the S&P 500 reaching the 7,800-point milestone while the Dow Jones snapped a two-week winning streak. US inflation data, combined with a decline in retail sales, has increased the probability of the Federal Reserve pausing rate hikes in September. Meanwhile, signals from the Trump administration regarding the Middle East situation have become a reason to dampen risk appetite. In the coming week, as the earnings season draws to a close, geopolitical factors and Federal Reserve monetary policy expectations may re-dominate the market, while the Cboe's "fear index" VIX, which measures market volatility, has fallen to a yearly low, potentially signaling the brewing of a new round of volatility.
Fed Rate Hike Expectations Cool Down
Last week, the US released a batch of economic data, centered on the monthly inflation report and retail sales figures reflecting consumer spending vitality. The Consumer Price Index (CPI) rose 0.1% month-over-month in July and 3.4% year-over-year, while core CPI increased 0.2% month-over-month and 2.6% year-over-year, in line with market expectations. Both year-over-year readings were 0.1 percentage points lower than in June. The US Producer Price Index (PPI) was flat month-over-month in July, below the expected 0.2%, and core PPI rose 0.2% month-over-month, below the expected 0.3%. Overall PPI increased 4.7% year-over-year, and core PPI rose 4.2% year-over-year, both significantly declining from June. Bob Schwartz, Senior Economist at Oxford Economics, said in an interview that energy prices remain the biggest uncertainty variable for US prices, and the Middle East conflict could push inflation in a completely different direction. Core inflation has fallen to 2.5%, but it has been difficult to break below that level since 2021, which also provides arguments for Fed hawks to continue supporting rate hikes. He believes that in the long term, productivity gains from AI are expected to curb inflation, but in the short term, the massive demand for data centers, semiconductors, and memory chips has already pushed up prices in some parts of the tech sector, creating a short-term hedge against AI's long-term anti-inflation prospects.
US overall retail sales fell 0.6% month-over-month in July, well below the expected 0.1%, marking the largest single-month decline since May 2025. Core retail sales fell 0.3% month-over-month, also below the expected 0.1%. The control group sales, which exclude restaurants, auto dealers, building materials stores, and gas stations and are directly included in GDP, fell 0.4% month-over-month, which is expected to drag on economic performance this quarter. The Atlanta Fed's GDPNow real-time estimate for Q3 GDP was revised down from 5.8% to 4.3%. Sal Guatieri, Senior Economist at BMO Capital Markets, stated in a report on retail sales, "Despite the boost from rising stock markets, U.S. residents took a breather in spending last month. Combined with weakening employment data and moderate core CPI inflation, this increases the probability of the FOMC maintaining policy patience in September." Schwartz believes that the latest US inflation and consumption data brought no major surprises, and the Fed has once again fallen into a familiar policy dilemma. Inflation remains above the Fed's 2% target but has eased, while a stable job market and rising stock market assets continue to support consumer spending. Policymakers are likely to stand pat, waiting for more evidence that inflation is clearly and sustainably declining. Inflation, employment, and consumption are pulling the Fed in different directions, and this "wait-and-see" policy stance is expected to persist well into next year.
Can It Go Further?
US stocks showed divergence last week, with geopolitical factors weighing on the Dow and Nasdaq, while the S&P 500 and the Russell 2000 small-cap index both hit new all-time highs this week. Positive earnings data boosted investor risk appetite. The market harbors concerns about the high valuations of recently surging AI-related stocks. Thomas Martin, Senior Portfolio Manager at GLOBALT Investments, said, "A lot of the market's current momentum comes from various AI sub-sectors. Applied Materials (AMAT.US) is a classic case: its earnings beat estimates and guidance was raised, but market expectations were already priced in high, ultimately leading to a 'sell the news' decline." US stock funds saw net inflows. As market expectations for a Fed rate hike cooled, risk assets became more attractive. LSEG Lipper data shows that US stock funds saw net inflows of $2.58 billion in the past week, fully offsetting the previous week's $1.36 billion in net outflows. US growth stock funds saw net inflows of $8.78 billion, the largest single-week net inflow since November 2024. Charles Schwab wrote in a market commentary that despite potential risks from the Middle East conflict, such as higher oil prices and rising Treasury yields, the core driver of the current market remains strong corporate earnings growth, and the core engine behind those earnings is the massive construction investment in AI infrastructure. The market is entering an accelerated short-squeeze rally, with the VIX volatility index at a relatively low 14.50, coupled with thin summer trading volumes. At the same time, the institution reminds investors to maintain a reasonable degree of skepticism.
Are There Potential Risks?
Beyond the Iran conflict, Charles Schwab lists the following four points: 1) August and September are historically seasonally weak windows for US stocks; 2) This year is a US midterm election year, and historically, markets tend to experience corrections in such years; 3) Fed Chair Warsh's policy expression is deliberately ambiguous, creating uncertainty in the policy path; 4) The 30-year Treasury yield has risen to a new cycle high. Looking ahead to the next week, Charles Schwab believes that the current technical trend of US stocks is positive, with new highs continuing to attract short covering and fund chasing. However, the Middle East conflict is an underestimated potential black swan, while long-end Treasury yields remain elevated. Investors have shown some complacency during this rally, with the VIX hitting a yearly low, and the market has barely factored in the Middle East conflict as a potential threat to the global economy.
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