The core CPI exceeded expectations, and the Federal Reserve's first rate hike in three years was “only an official announcement”. Why did US stocks not fall but rise?

The Zhitong Finance App learned that the US CPI for August added another spark to the already highly tense US Federal Reserve's September interest rate meeting. The overall inflation data was in line with expectations, but the core CPI accelerated again from month to month and was higher than market expectations. Combined with previous strong PPI and employment data, the market's bet on the Federal Reserve's interest rate hike of 25 basis points next week is rapidly heating up. The CME FedWatch tool shows that before the CPI was announced, the probability that market pricing would raise interest rates in September was about 70%; after the data was released, this probability once approached 90%. If the Federal Reserve actually acts next week, this will be the first rate hike in three years.

However, it is worth paying attention to the market reaction: US bond yields have risen, but US stock index futures have not declined as intuitively. The three major US stock indices all rose more than 1%. Behind this, the market seems to be trading not just the CPI itself, but a repricing between inflation, interest rates, oil prices, geopolitical risks, and technology stock profits.

Core CPI is hot: gasoline, housing, and transportation services are rising

According to data released by the US Bureau of Labor Statistics on Friday, CPI rose 0.4% month-on-month in August and slightly rose 0.1% in July; it rose 3.4% year-on-year, the same as in July, all in line with market expectations. Excluding food and energy, core CPI rose 0.3% month-on-month, higher than market expectations of 0.2%, and accelerated from 0.2% in July; core CPI rose 2.4% year on year, slightly down from 2.5% in July.

The report shows that US inflation has made little progress towards the Federal Reserve's 2% target under continued pressure from Iran's war, tariffs, and data center construction.

By category, gasoline prices rose 3.9%, accounting for more than one-third of the index's increase. Affected by the escalation of tension in the Middle East, the overall energy index rose 2.1%, up 16.3% year on year. Food prices rose slightly by 0.1%. Among them, household food costs remained flat, and the food index rose 2.7% year on year. Another important factor was the 0.3% increase in housing costs, which had slowed in the previous two months. The price of transport services increased by 0.5%. The 0.4% increase in used car and truck prices and the 0.3% increase in new car prices appear to be part of the general rise in the index.

Notably, the Federal Reserve tracks the personal consumption expenditure (PCE) price index, not the CPI. Although the core CPI fell slightly to 2.4% year over year, the core PCE in July was still 3.3% year over year, far higher than the Federal Reserve's 2% target.

PPI resonates with employment, and core PCE estimates move upward

The PPI data released on Thursday also showed that inflationary pressure is stubborn. PPI rose in August, and several key segments showed strong performance, and these segments will be included in PCE inflation calculations. Coupled with Zhou's strong August employment report, the market's expectations for next week's interest rate hike were further supported.

After the PPI data was released, economists' estimated range of 0.15% to 0.28% month-on-month increase in August was 0.15% to 0.28%, up 0.2% in July; the estimated range for the year-on-year increase was 3.2% to 3.3%, compared to 3.3% in July. Furthermore, the August PCE report will include methodological adjustments. Some economists believe that this change may lower the core inflation rate by a few basis points.

Furthermore, some economists believe that import tariffs, especially the tariffs recently imposed on Canada, are causing price pressure to continue. Dissatisfaction with high gasoline and food prices has led to a marked decline in US President Trump's approval rating, and may cause the Republican Party to lose control of Congress in the November midterm elections.

As of now, there are still differences within the Federal Reserve over the next steps. Federal Reserve officials kept interest rates unchanged at the previous five meetings, but at the July meeting, three officials objected and supported a 25 basis point hike.

Federal Reserve Chairman Walsh has been unwilling to reveal trends, but he said last month that “there is still work to be done” if the Federal Reserve cannot “be convinced that potential inflation is moving clearly and fast enough towards the target.” Federal Reserve Governor Waller said at an event last week that if the data confirms that inflationary pressure is cooling down, he would prefer to keep interest rates unchanged. This remark once lowered the probability of interest rate hikes. However, after the release of the latest CPI data, the futures market showed that investors think next week's interest rate hike is almost a foregone conclusion, and expect another rate hike before the end of the year.

Meanwhile, Trump continues to pressure the Federal Reserve to cut interest rates, posting on social media last week: “Lower interest rates, otherwise I will stop trading with countries that have deficits with us.” Economists blame the sharp rise in long-term US bond yields on this kind of political intimidation. Some people expect that the Federal Reserve may choose to tighten its policy next Wednesday to emphasize its independence.

Nationwide's chief economist Kathy Bostjancic said, “Chairman Walsh and others are signaling that interest rates can only stay the same if inflation continues, and the August report released today did not provide such conditions. Furthermore, the resurgence in crude oil, gasoline and diesel prices has heightened concerns that rising energy prices may be transmitted to other goods and services as well as inflation expectations.” The agency currently anticipates that the Federal Reserve will raise interest rates by 25 basis points next week.

Why aren't US stocks falling but rising? The market is trading a triple logic

Although expectations of the Fed's interest rate hike continued to heat up after the CPI data was released, and US bond yields continued to rise, US stock index futures further expanded their gains.

On the face of it, “inflation exceeds expectations and interest rate hikes are heating up” should be bad for the stock market. But the logic of current market transactions is more complicated.

First, this CPI is not completely out of control. Overall CPI was in line with expectations month-on-month and year-over-year, and core CPI was also in line with expectations. Only core CPI was significantly higher than expected. As a result, the market did not receive a signal that “inflation is out of control” sufficient to completely change the path of future monetary policy. In other words, the expected rise in interest rate hikes is bad, but this shortfall itself has already been traded quite a bit ahead of schedule by the market.

Bank of America senior economist Stephen Juno commented after the CPI data was released: “This report actually doesn't make us more concerned about the outlook for inflation,” although it will prompt the Federal Reserve to raise interest rates next week.

Second, the fall in oil prices has become another main line in the stock market. Over the past few days, oil prices have broken through $100 per barrel and continued to rise, which is an important factor in suppressing risk appetite in US stocks. Brent crude oil futures surged more than 6% on Thursday. At one point, the market worried that energy prices would further spread to inflation and corporate costs, and forced the Federal Reserve to maintain austerity for a longer period of time. However, there was a marked decline in oil prices on Friday. Brent crude oil was once close to 110 US dollars/barrel, then declined due to news in the market that Middle Eastern countries were trying to reach a temporary agreement with Iran on shipping arrangements in the Strait of Hormuz. Both Brent and WTI fell more than 3% in the latest deals.

Instead, this is an important benefit for US stocks. Because what the market is really worried about is not “whether the Fed will raise interest rates by 25 basis points next week” itself, but rather: the Middle East conflict continues to escalate → oil prices continue to rise → inflation rises again → the Federal Reserve is forced to continue to raise interest rates → US bond yields rise further → stock valuations are under pressure. Today, oil prices have clearly fallen from high levels, which means that this risk chain has eased to a certain extent. As a result, the market actually had an interesting hedging: the CPI heat boosted expectations of interest rate hikes, but falling oil prices reduced the risk that future inflation would continue to worsen.

Third, technology stocks also have an advantage in being independent. Oracle (ORCL.US)'s latest results and performance guidance are strong, driving its stock price to soar ahead of the market and providing support for NASDAQ futures. According to market data, the increase in NASDA100 futures was slightly higher than that of S&P 500 futures and Dow futures. This shows that currently US stocks are not simply trading “interest rates.” For technology stocks, AI investment, cloud computing, and enterprise software demand remain independent profit drivers. As long as corporate profit expectations are strong enough, it is possible to offset some of the valuation pressure brought about by rising interest rates.

Previously, the market had been under pressure for several days due to rising oil prices, rising PPI, and rising US bond yields. On Thursday, the US PPI rose 5.4% year on year in August, while oil prices surged more than 6%, driving US bond yields to continue to rise. The three major US stock indices fell for the fourth consecutive trading day. In other words, before the CPI was announced, the market had already pre-priced “inflation+the Federal Reserve is more hawkish.”

Therefore, when the final CPI was announced was only the core slightly higher than expected month-on-month, rather than significantly exceeding expectations across the board, there was no need for another large-scale sell-off in the market.

From a transactional perspective, this is closer to “worst-case expectations have not worsened further.” It can even be understood that the market is shifting its attention from “whether the Federal Reserve will raise interest rates” to “how many more times after raising interest rates.” If the September rate hike is close to being determined, then what the market is really concerned about will be whether to continue to raise interest rates in October and December, and the interest rate path for 2027.

The real risk is still the second impact of “oil price+inflation”

However, the rise in US stock futures does not mean that the risk of inflation has been lifted. In fact, the biggest variable in the current market is still the price of oil.

In the US CPI for August, gasoline prices rose again after falling for two consecutive months; at the same time, the PPI announced on Thursday also showed that the rise in energy prices was being transmitted to the production side. If oil prices break through $110 again or rise further, then today's market's optimistic interpretation of CPI may quickly reverse.

What is particularly alarming is that if the rise in oil prices is not a short-term shock, but continues due to supply blockages in the Strait of Hormuz, then it may simultaneously drive up overall inflation, reduce actual consumer income, and force the Federal Reserve to maintain higher interest rates. This will form the most unfavorable combination for US stocks: high oil prices+continued high inflation+continued interest rate hikes by the Federal Reserve + rising US bond yields.

Conversely, if the situation in the Middle East eases marginally and oil prices continue to fall from more than $100, then even if the Federal Reserve raises interest rates by 25 basis points in September, the market may see it as a “fully priced interest rate hike” rather than the beginning of a new cycle of austerity.

Therefore, the real meaning of today's rise in US stock futures is not that the market thinks this CPI is good, but rather that the market believes that although this CPI is hawkish, it is not bad enough to break the previous trading framework; at the same time, falling oil prices and mitigating geographical risks have provided new breathing space for risky assets.

Next, what US stocks really need to pay attention to will not only be whether interest rates will be raised in September, but whether oil prices will continue to fall, and whether the Federal Reserve will continue to raise interest rates after September. These two variables are likely to determine whether this round of rebound in US stocks is only a recovery after an overrun decline, or whether they can return to an upward trajectory.