Fed Signals Rate Hold as Inflation Moderates, Markets Rally on AI Earnings
Markets rallied as inflation data came in line with expectations and AI infrastructure companies beat earnings, reducing the urgency for Fed rate hikes despite sticky services inflation.
Market Reaction to Inflation Data
Prices rose 3.4% in July compared to a year earlier, marking a slight cooldown from an annual inflation rate of 3.5% in the prior month. Inflation eased slightly in July but price increases stayed above the pace recorded before a surge in fuel prices set off by the Iran war. The reading matched economists' expectations.
In-line inflation will keep the 'no need to hike rates' narrative that took hold after last week's jobs report intact, according to Ellen Zentner, chief economic strategist at Morgan Stanley Wealth Management. This sentiment marks a significant shift following the U.S. loss of 23,000 jobs in July, which marked a decline from 57,000 jobs added in June.
AI Sector Strength Boosts Equities
The latest quarterly results and guidance from CoreWeave and Super Micro Computer reassured investors that demand in the artificial intelligence buildout is stable. CoreWeave shares jumped 19% after the cloud infrastructure mainstay's second-quarter adjusted operating income margin of 5% exceeded expectations, while its revenue doubled from a year ago. Super Micro Computer added 19% following a strong earnings and revenue forecast for the first quarter.
Fed Policy Outlook and Labor Market Trends
Fed Chair Kevin Warsh, who took the helm of the central bank this summer, has repeatedly vowed to dial back inflation. Inflation stands more than a percentage point above the Fed's target rate of 2%. However, the softer labor-market data, combined with the slowest pace of wage growth in nearly five years, helped alleviate inflation concerns. As a result, investors have scaled back expectations for Fed tightening, with bond markets now assigning less than a 50% probability of a rate hike in September.
What's Ahead
There will be another round of inflation data before the September FOMC meeting, so the storyline could still change. But unless those numbers tell a much different story, the Fed will likely still be in a position to leave rates unchanged next month.