Wednesday’s Rate Decision to Speak Volumes About Inflation Fight

Executive Summary

Last week, stocks finished lower in a holiday-shortened week as higher oil prices, rising interest rates, and renewed inflation concerns pressured both equity and fixed income markets.

The S&P 500 Index fell 0.8%, while the Russell 2000 small-cap index declined 2.4%, reflecting the pressure of higher long-term interest rates.

West Texas Intermediate (WTI) crude oil settled near $100 a barrel as the war with Iran tightened global oil supply. Diesel prices hit a record $6.20. The 10-year Treasury yield closed near 5%, its highest level since October 2023. That move followed Friday’s Consumer Price Index (CPI) report, which came in slightly higher than expected, pushing the probability of a 25-basis-point rate hike at this Wednesday’s Federal Open Market Committee (FOMC) meeting to 88%.

Key Takeaway: We believe the markets will view a rate hike by the Federal Reserve (Fed) as a positive and give the Fed greater credibility in its commitment to fighting inflation. At the same time, Oracle Corporation’s (ORCL) earnings report showed that demand for artificial intelligence (AI) infrastructure remains very strong.

The S&P 500 has been oversold on a daily basis. This could be a sign that equities can rally on good news and would be counter to the historical decline that takes place in September (the 5-year average is a decline of 2.68%).

Key Market Levels & Indicators

Markets Have Already Priced In a Fed Hike

The FOMC announces its interest rate decision Wednesday afternoon. It will publish a Summary of Economic Projections (SEP), detailing members’ expectations for interest rates, inflation, and economic conditions, followed by a news conference by Fed Chair Kevin Warsh.

At last Friday’s close, the Fed funds futures market priced an 88% chance of a 25-basis-point hike, raising the target rate from 3.50%–3.75% to 3.75%–4.00%. If the FOMC holds rates steady, the market will be surprised and the move will likely be taken as a negative.

• CPI Overview: Headline CPI rose 0.4% in August (3.4% YoY). Core CPI (excluding food and energy) rose 0.3% on the month, slightly above the 0.2% expected.
• PPI & Labor: Producer prices came in hotter than expected due to rising energy costs. Meanwhile, private domestic purchases were solid, jobless claims remained near 60-year lows, unemployment held at 4.1%, and August payrolls surprised to the upside.

10-Year Treasury Yields Near 5% Doing the Fed’s Work

The 10-year Treasury yield reached 4.98% before finishing the week at 4.97%, while the 30-year yield touched its highest level since 2007 near 5.40%.

Higher long yields raise borrowing costs for mortgages and auto loans while elevating the discount rate applied to long-duration growth stocks. Existing home sales in August remained depressed below a 4-million annual rate. We expect the 5% yield level on the 10-year to hold, and yields could ease if the Fed delivers a rate hike that restores market confidence in inflation control.

Oil Above $100 Is an Inflation Problem

WTI crude settled at $100.05 after touching $104 Friday morning. Ongoing conflict with Iran continues to severely curtail global supply:

• Houthi forces seized control at the Bab al-Mandeb Strait.
• Saudi Arabia shut down its East-West pipeline following drone attacks, cutting the primary bypass around the Strait of Hormuz and reducing flow by an estimated 2 to 3 million barrels a day.

With oil breaking above resistance at $97, momentum could carry prices toward $110–$120. The Energy sector remains our top overweight sector and is the best-performing sector year-to-date, up nearly 45%.

AI Demand Remains Strong: The Constraint Is Memory and Money

Earnings from Oracle (cloud infrastructure revenue up 121%) and Dell confirm that the AI infrastructure buildout remains extremely powerful:

• Dell: Booked $60.9 billion in AI server orders in a single quarter (up from $24 billion), ending with a $95 billion backlog.
• Hyperscaler CapEx: Spending by Amazon, Alphabet, Microsoft, and Meta is expanding from the mid-$400 billions in 2025 to $700–$800+ billion in 2026.

Supply Bottleneck: High-bandwidth memory (HBM) chips from SK Hynix, Samsung, and Micron (MU) are sold out through 2026, with 2027 capacity already being pre-allocated. Because new semiconductor fabs won’t deliver major output until mid-2027 or later, physical memory supply—not customer demand—is the primary bottleneck capping server shipments.

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