Investors are now seriously weighing the possibility of a US Federal Reserve rate hike in September, following a week of rising oil prices and a stalemate in the Middle East, which have reignited concerns over high inflation and potential market corrections. The market must price in at least one rate hike to unlock operational flexibility for the fourth quarter. However, the breadth of North American economic growth is far narrower than during 2004-06 or 2021, meaning the conditions for a sustained tightening cycle are not in place.

With various volume-price sentiment indicators in the A-share market having already retreated to subdued levels, if the hike is merely symbolic and precautionary, the release of rate risk should be viewed as a buying opportunity rather than a sell signal. A September Fed rate hike would likely mark the beginning of the end of the correction that has been underway since July. AI remains one of the few sectors capable of withstanding rising rates, but as rate expectations continue to firm, market divergence (K-shaped) may widen again, suggesting investors maintain a portfolio tilted toward AI and energy-chemicals, with the AI narrative shifting more toward the North American supply chain.

This week, investors have begun to seriously consider the potential for a September rate hike. High oil prices and the ongoing Middle East standoff have revived fears of high inflation and market volatility. Recent escalations in the region have extended the disruptions to crude markets beyond just Strait of Hormuz transit risks, now encompassing threats to Saudi energy infrastructure and alternative export routes through the Red Sea. As of September 11, the crack spreads for ICE diesel and NYMEX heating oil surged to $92.73 and $111.90 per barrel, respectively, expanding by $70.99 and $79.18 per barrel from the end of last year, both hitting new annual highs. The sharp rally in refined product prices means the impact of this energy-chemical price surge on future CPI could be even stronger than the first closure of the Strait of Hormuz. China is no longer acting as a buffer for demand in this supply shock, with crude imports rebounding notably in August, narrowing the room to balance global supply and demand by curbing demand. Investors worry that high inflation expectations could again trigger a sharp market correction similar to the one seen in March. However, TIPS pricing suggests the market views the oil shock as a short-term inflation driver, while long-term inflation expectations remain relatively stable. On the day US PPI was released this week, 5-year, 10-year, and 30-year TIPS breakeven inflation rates rose by 5, 3, and 2 basis points to 2.46%, 2.40%, and 2.32%, respectively, before falling back to 2.40%, 2.36%, and 2.28% after the CPI release. Compared to end-August, these still show increases of 9, 5, and 2 basis points, with the shortest maturities seeing the largest rises.

The market needs to price in one rate hike to create room for fourth-quarter maneuvers. Since September, commodity market pricing for a Fed hike has risen notably, with CME FedWatch showing the probability of a 25bp hike in September climbing from around 58% at the start of the month to about 85% after the inflation data. However, the A-share market has remained hesitant in pricing the hike, repeatedly trading the precious metals sector following the Jackson Hole meeting, with share prices outperforming their US counterparts, until Brent and WTI oil prices both broke $100 this week, triggering a clear correction. This suggests the market still views the Fed's move as precautionary and symbolic. Our prior assessment characterized the market as a range-bound one with valuation headwinds but resilient fundamentals, where staged opportunities depend on localized risk release and pricing to create room. Even a precautionary hike needs to be priced in before the market can find operational space. We therefore lean toward viewing this week's accelerated correction as a within-expectations pricing of the rate hike, and once priced, the fourth quarter should offer more room to maneuver.

The breadth of North American economic growth this cycle is far weaker than during 2004-06 and 2021, so the conditions for a sustained rate-hike trend do not exist. We compared current North American economic data against the property boom of 2004-06 and the post-pandemic recovery of 2021. The US composite economic activity diffusion index averages -0.023 this year, versus 0.154 in 2004-06 and 0.335 in 2021. New home starts average 1.36 million units this year, versus 1.94 million and 1.6 million in the two earlier periods. The personal savings rate stands at 3%, compared to averages of 3.23% and 11.3% in those periods. Real retail sales growth is 1.65% year-on-year, versus 2.93% and 13.68% averages. The share of ten private industries with expanding employment averages 50% this year, versus 75% and 72% in the earlier periods. In short, the breadth of North American growth is far weaker than in 2004-06 and 2021. Growth drivers are concentrated almost entirely in AI investment, with US corporate bond issuance up 29.8% year-on-year in the first eight months of this year, compared to averages of 11.8% in 2004-06 and -11.3% in 2021. This massive private-sector credit expansion has even crowded out Treasury demand, pushing the 30-year yield to 5.22%, above the 5.2% seen in June 2007. The main industries driving private debt expansion are information technology and telecom services, with Q3 earnings growth expectations of 62.6% and 50.7% respectively, versus just 3.1% and 2.6% for discretionary and staples.

Sustained rate hikes could significantly damage non-AI traditional industries while having limited impact on AI-related sectors. In this economic backdrop, continuous rate increases to combat inflation may not hurt AI-linked investment, as compute shortages ensure cloud infrastructure spending still yields substantial returns, while non-AI sectors could suffer from high rates and ongoing tightening. Rate hikes would neither curb AI investment nor address the price increases caused by AI's competition for resources and materials (such as memory), nor resolve the upstream energy-chemical cost pressures from Middle East conflicts. Instead, they risk further narrowing the breadth of growth, squeezing non-AI traditional and household sectors. This undermines the credibility of the Fed's commitment to restoring its inflation target and reputation, which is why the market consistently treats any hike this year as precautionary and gestural. We believe a September Fed rate hike should signal the correction since July is nearing its end—a risk being realized, not a downward revaluation of stocks.

Various volume-price sentiment indicators have already returned to subdued levels, and the release of rate risk should be viewed as a buying opportunity rather than a sell signal. Our constructed investor sentiment index has entered a freezing zone, and high odds for bargain-hunting follow significant volume contraction. After August's volume-dried consolidation, the crowded trades in tech hardware have clearly improved: the MA5 share of trading for electronics and telecoms fell from over 40% at the June-July highs to a low of 28.2% on September 4, back to end-April levels. The MA10 share of the top 5% most-traded stocks dropped from a 52% high to 44.7% on September 11, matching April 16 levels. On derivatives, onshore liquidity pressure has eased markedly compared to July's deep correction. As of September 11, IV for CSI 1000 and CSI 300 index options stood at 28.3% and 17.9%, respectively, both near historical calm-period medians. Even on volatile trading days this month (e.g., September 4 and 11), implied volatility on index options did not spike significantly. Following July's violent deleveraging, margin funds did not meaningfully raise risk appetite in August. As of September 10, margin buying represented 8.5% of total turnover (MA5), sitting at the 9.0th percentile since 2025 and the 54.7th percentile since 2021. Channel research indicates that sampled active private funds sharply raised positions to 79% in the first week of August, then cut for four straight weeks to a low level, with the latest reading (September 4) at 70.8%, the 22.7th percentile since 2021 and the second-lowest since October 2024, behind only the week of July 17.

AI remains one of the few sectors able to resist rising rates, and continued upward revisions in rate expectations may reinforce K-shaped divergence. While a rate hike would lift financing costs uniformly across the economy, sectoral differences in prosperity lead to varying price-demand curve slopes, with weaker non-AI industries suffering more demand damage. This year, the AI/non-AI equity performance divergence across China, the US, Japan, and Korea has been highly correlated with market expectations for Fed rates. Recent EM currency depreciation, the high-oil-price environment, and tightening global liquidity will constrain traditional investment and consumption, whereas AI, with its technological dividends and capital efficiency, remains one of the few industries resilient to rate headwinds. Since September, as Fed hike expectations have firmed, K-shaped divergence across major global markets—especially the US—has intensified at the margin. We expect that if rate expectations continue to rise, K-shaped divergence will strengthen again, with AI assets likely to reclaim market leadership after July's consolidation. However, given that institutional investors are already heavily overweight electronics and telecoms at current A-share levels, and that these sectors still carry a high share of underwater chips after July's deep correction, the rally may lack smoothness, and the intensity of K-shaped divergence is likely to be weaker than in Q2. Therefore, after the rate hike is priced in, the new leg of the rally may concentrate in tech names not heavily held by institutions (represented by new optical communication technologies and PCB), with trading structure driven and led by active capital. Conservative funds may instead rotate into defensive sectors (banks, coal) or dividend-like segments (energy-chemicals).

Awaiting the rate hike, we recommend maintaining an AI-plus-energy-chemicals allocation structure. We reiterate our view of a range-bound market with valuation headwinds but resilient fundamentals, where staged opportunities depend on localized risk release and pricing to create room. If the Fed hikes in September, it should be seen as a signal that the correction since July is nearing completion and positioning space is opening, not the start of a new downturn. Already-depressed sentiment indicators and rapidly declining active-fund positioning support this judgment. Structurally, with long-end US Treasury yields likely to keep climbing due to strong private-sector crowding out, K-shaped divergence across China, US, Japan, and Korea markets may re-emerge; however, constrained by high holdings, a weaker narrative than Q2, and deteriorating chip structures, the divergence intensity will likely be milder than in Q2. On allocation, after rate-risk pricing, tech opportunities should concentrate in directions benefiting from increased manufacturing complexity (e.g., new optical communication tech, PCB, advanced packaging) and volume-growth logic (e.g., wafer fabrication and gas turbines), with non-institution-heavy names offering greater upside. Given the RSI effect on model inference speed, frontier models like Astra breaking through in physical AI verticals such as spatial intelligence, and the rising heat around anti-distillation, the North American chain may be more advantageous in the coming period. Outside tech, we suggest staying focused on energy-chemicals and leading brokers with overseas expansion potential, while steady allocations can watch banks and coal.

Key risks include escalating China-US friction in tech, trade, and finance; domestic policy intensity, implementation, or economic recovery falling short; sharper-than-expected tightening in global liquidity; further escalation of conflicts in Russia-Ukraine or the Middle East; and slower-than-expected inventory digestion in China's property sector. This content is for reference only and does not constitute investment advice. Investors should act at their own risk.