Inflation, Oil Prices Land at Wall Street’s Doorstep

Stocks slipped last week as sticky inflation and rising oil prices have all but cemented the case for a Federal Reserve rate hike this Wednesday. The S&P 500 lost about 0.8%, the Dow gave back nearly 1.6%, the Nasdaq shed 0.7%, and small caps got hit hardest, falling nearly 2.5%. Bond yields pushed to multi-year highs mid-week before easing Friday. Commodities were a story unto themselves: oil surged toward $100 per barrel on continued Iran conflict, while gold gave back a bit after a strong summer run.

The drivers: Sticky CPI, hotter PPI, oil above $100, University of Michigan preliminary consumer sentiment index (Michigan Consumer Sentiment) at a summer low, and a strong chance of a Fed hike Wednesday.

Yes, the Federal Reserve will likely raise interest rates a quarter point Wednesday. Yes, inflation is still stuck around 3.4%. Yes, oil is trading above $100. And yes, small caps just had their worst week in months. Now let me tell you why none of that may change the bigger story.

Corporate earnings are still growing, and the largest capital spending cycle in the history of American business is still accelerating. Oracle just posted a quarter that included cloud infrastructure revenue growing 121% and a $455 billion contract backlog. Nvidia posted $96 billion in a single quarter three weeks ago. Broadcom guided to another 93% revenue jump in the current quarter. Microsoft plans to triple its data center capacity. And the spillover is real. Utilities are being asked to add power capacity at a pace not seen in decades to feed these data centers, and industrials are ramping up production of everything from cooling equipment to transformers to structural steel to make the buildout possible. The August jobs report added another 162,000 positions, nearly triple what economists expected, and prior months were revised higher. This is not just a technology story. It is showing up in earnings, in employment, and in real economic activity across the market.

One 25 basis point rate hike may not have that much of an effect. Here’s a nuance worth keeping in mind: the Federal Reserve only sets short-term interest rates. The market sets longer-term rates, and it appears to have already priced in this week’s hike, which is likely why Wednesday’s decision may be less of a moment than the headlines suggest. If the Federal Reserve can consider raising rates while corporate earnings are printing these kinds of numbers, that tells you something about how strong the economy actually is underneath.

A note on seasonality worth remembering: September has historically been the weakest month of the year for stocks, but October through December has been the strongest three-month stretch, going back nearly a century. The market has a habit of testing patience in September before potentially rewarding it in the fourth quarter. Expect volatility this week as Chair Warsh delivers his press conference and updated projections. Over the longer arc, earnings drive stock prices. And earnings are still going the right way.