U.S. stocks plunge to end August, what will happen in September? Wall Street closely watches this report

Last Friday, the Philadelphia Semiconductor Index fell by 3.2%, marking its largest drop since April.

Last week, the U.S. stock market ended August trading with a late-session sell-off, halting a three-week winning streak. U.S. consumer spending in July grew at the fastest pace since March, while the Federal Reserve's preferred inflation gauge reached its highest level in five months, putting pressure on heavyweight tech stocks.

This week, the U.S. labor market report will once again test the health of the U.S. economy and challenge investors' confidence in an imminent rate cut, which is also seen as key to the U.S. stock market's renewed push for record highs.

Inflationary Pressure Combined with Challenges to Fed Independence

Last week, key U.S. economic data mainly focused on the inflation indicator most closely watched by the Federal Reserve. The July Personal Consumption Expenditures (PCE) index rose 0.2% month-on-month, slowing by 0.1 percentage points from the previous month, mainly due to falling costs of gasoline and other energy goods. Year-on-year, it increased by 2.6%, unchanged from June.

Excluding the more volatile food and energy sectors, core PCE rose 0.3% month-on-month, and the year-on-year growth accelerated to 2.9%, the highest level since February. Core PCE is the price parameter the Fed focuses on and is a key predictor of future inflation, moving further away from the Fed's stated 2.0% target.

The good news is that consumer spending in July grew by 0.5%, the largest increase in four months, indicating that demand remains resilient in the face of stubborn inflation. However, the subsequent University of Michigan consumer sentiment data came in below expectations. Notably, one-year inflation expectations stood at 4.8%, and five-year expectations at 3.5%, both higher than July's 4.5% and 3.4%. Currently, Americans seem to be continuing to spend, but it is unclear how long this momentum can last amid rising prices and declining consumer confidence.

Bob Schwartz, Senior Economist at Oxford Economics, told Yicai Global that the PCE data basically met expectations, and wages and salaries are steadily increasing. Compared to June, the impact of inflation on real income is smaller, but as tariffs are increasingly passed on to consumers, inflation-adjusted income losses will increase. In fact, Fed officials are increasingly concerned about downside risks in the labor market, and the challenge of their dual mandate is growing.

The Fed will receive another employment report and Consumer Price Index report before its next meeting. Fed Chair Jerome Powell stated at the Jackson Hole central bank symposium this month that the current economic outlook, coupled with rising labor market risks, may require an adjustment in policy stance. Federal funds rate futures pricing shows that the probability of a rate cut in September is close to 85%.

All signs indicate that the balance within the Fed seems to be tilting toward resuming easing, but the data-dependent stance has not changed. The Fed's number three official, New York Fed President Williams, said last week that rates may come down at some point, but policymakers need to see the upcoming economic data. "In my view, every meeting is a live decision, risks are becoming more balanced, and it is very important to accurately assess data performance," he said.

Schwartz told Yicai Global that private sector job growth in the August nonfarm payrolls is expected to slow further. However, due to continued weak labor force growth, the unemployment rate will remain at 4.2%. The sharp decline in net immigration is a driving factor behind the slowdown in labor force growth. On the other hand, he noted the controversy over the tenure of Fed Governor Cook, and that the Fed's independence is facing challenges from Trump, directly reflected in the steepening of the Treasury yield curve, which in turn increases policy path uncertainty.

Concerns Over Cooling Artificial Intelligence

Last week, U.S. stocks plunged late in the session, giving back gains from earlier in the week and heading into the Labor Day weekend. However, with the end of August trading, the S&P 500 and Nasdaq both posted gains for the fourth consecutive month.

According to Dow Jones Market Data, most sectors fell last week. Utilities had the largest decline, down 2.1%, followed by consumer goods down 1.7%, and industrials down 0.8%. Healthcare, consumer discretionary, real estate, and technology sectors also saw slight declines, while the materials sector was flat. Meanwhile, the energy sector rose 2.5%, and financials and communication services each rose 0.7%.

In terms of capital flows, although the tug-of-war between Trump and Fed independence continues, U.S. equity funds saw net inflows again last week. Data provided by LSEG to Yicai Global showed that U.S. equity funds had a net inflow of $571 million in the past week, reversing the previous week's net outflow of $2.39 billion.

The market is focusing on heavyweight tech stocks, especially the development prospects of the artificial intelligence industry. Last Friday, the Philadelphia Semiconductor Index fell by 3.2%, its largest drop since April. Chip giant Nvidia's stock fell more than 5% after its earnings report, as the company's performance did not meet investors' lofty expectations, though spending related to AI infrastructure remains strong. After OpenAI CEO Sam Altman warned of a potential AI bubble, concerns about the pace of AI development have increased in the market.

UBS stated that the performance of large tech companies, including Nvidia, highlights that the outlook for such companies "remains compelling." At the same time, it pointed out that while market valuations are at the high end of historical ranges, market sentiment does not appear to be overly optimistic.

Charles Schwab wrote in its market outlook that the breadth of the U.S. stock market has recently improved, mainly due to the strength of cyclical sectors such as consumer discretionary, industrials, and financials, and the S&P 500 has reached the 6,500-point milestone. It should be noted that the late-session sell-off was not broad-based, volatility did not increase sharply, the VIX fear index remains below 16, and U.S. Treasury yields did not surge.

The institution believes that the performance of the labor market data in the coming week will be crucial, and the August nonfarm payrolls could directly determine whether rate hikes start at 50 basis points. Technically, all major indices are above their 20-day moving averages, and the Relative Strength Index (RSI) is close to or above 60. Overall, the market remains strong, but some bumps are inevitable in the process of hitting new highs.