TradingKey - Following the U.S. Bureau of Labor Statistics' release of the August CPI, market expectations for Fed rate hikes heated up significantly. However, U.S. stocks unexpectedly snapped a four-day losing streak, with the Dow Jones Industrial Average rising over 600 points early in the session.

Looking at the details of the newly released CPI report, the August CPI rose 3.4% year-over-year, meeting market expectations and remaining flat compared to July; on a seasonally adjusted basis, it rose 0.4% month-over-month, also matching expectations, but noticeably higher than July's 0.1%.

What truly drove up rate hike expectations was core CPI inflation: core CPI (excluding food and energy) rose 0.3% month-over-month, higher than the expected 0.2%, while the year-over-year rate eased from 2.5% in July to 2.4%. This indicates that on a 12-month basis, U.S. inflation did not worsen further. However, looking at the most recent month, price pressures re-emerged. The gasoline index rose 3.9% during the month, contributing over a third of the overall monthly CPI increase; the energy index rose 2.1%, up 16.3% year-over-year. The shelter index rose 0.3%, airline fares rose 2.7%, lodging away from home rose 2.4%, and communications rose 2.3%.

In short, what truly exceeded expectations in the CPI report was the core month-over-month rate, which serves as a policy bellwether. However, the rise in core inflation was mainly driven by hotels and airline fares (typically viewed as seasonal factors), while other core goods and services remained relatively modest, with rent rising less than 0.2% month-over-month.

The market likely believes price hikes related to travel and holidays are unsustainable, which also explains why gold initially fell before rebounding, and the 10-year U.S. Treasury yield rose first before declining following the data release.

Why Rising Rate-Hike Expectations Should Theoretically Weigh on US Stocks

For the Federal Reserve, this report is the last major inflation reading before its September 15–16 policy meeting. Federal Reserve Governor Christopher Waller previously stated that if August inflation continued to improve, he would support keeping interest rates unchanged, while implying that rate decisions would remain highly data-dependent.

The core month-over-month reading coming in at 0.3% instead of 0.2% effectively squeezed the room for holding rates steady. Interest rate futures indicated that the market at one point fully priced in at least two 25-basis-point rate hikes for the year.

If judged solely by this logic—'hawkish CPI -> rising rate hike expectations -> higher U.S. Treasury yields -> pressure on U.S. stocks'—U.S. equities should have seen a continued sell-off rather than a rebound.

Why Are US Stocks Rising Instead?

First, the rate hike had been priced in advance, leading the market to shift to trading on the exhaustion of bad news.

Prior to the data release, the probability of a September rate hike was already close to 70%. The only real surprise was that the core month-over-month figure came in 0.1 percentage point higher, rather than delivering another inflation report showing a total loss of control. The 10-year U.S. Treasury yield touched 4.992% intraday, its highest level since October 23, 2023, before quickly pulling back as it approached 5%. The policy-sensitive 2-year yield similarly spiked before giving back its gains.

Judging from trading outcomes, bonds were sold first and then bought, while equities rose instead of falling. This reflected a classic pattern where the market viewed a rate hike as a 'done deal' and thus began trading on the exhaustion of bad news. In other words, the market stopped trading on 'whether a rate hike would happen' and started trading on 'whether the worst-case scenario after the hike had already been priced in.'

Second, the structure of inflation led the market to view the upside surprise as a seasonal factor.

Gasoline, airfares, and hotel stays were the main contributors to August price increases, while food prices remained mild, medical care and auto insurance fell, and rent did not show an out-of-control acceleration. For equities, if the upside surprise came from travel and energy rather than a broad-based spread across rent, wages, and services, then a rate hike could be understood as a one-off fulfillment rather than the start of a new tightening cycle.

It can be understood that traders were more willing to accept a single, well-anticipated rate hike, but reluctant to accept a narrative of 'broadly spreading inflation and consecutive rate hikes.'

Finally, falling oil prices provided support for risk appetite. CPI was not the only factor driving asset moves that day; WTI crude oil futures fell about 3% on the day, giving back part of the week's gains as signs of easing emerged in the Middle East. The pullback in oil prices directly alleviated fears that 'the next inflation report would be worse,' meaning part of the equity rally was trading on the easing of energy shocks rather than cheering the CPI numbers.

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