This week, investors aggressively sold off chip stocks late in the session, driven by concerns over massive capital spending by major tech companies on artificial intelligence. The market is now awaiting a new wave of big tech earnings reports.

Meanwhile, a sharp rise in oil prices has pushed up US Treasury yields, with markets betting that the Federal Reserve will tighten monetary policy again this year. Next week, the Fed's decision, tech earnings, and geopolitical factors are set to be key sources of market volatility.

Fed Rate Hike Expectations Rise

Recent US economic data has been relatively light, with the focus on the S&P Global Purchasing Managers' Index (PMI) and weekly initial jobless claims. US economic activity improved in July, with businesses accelerating hiring. The services PMI rose to 53.6, an eight-month high, from 51.2 in the previous month. The manufacturing PMI edged down to 53.8 from 53.9, falling short of the market's 54.3 forecast.

The labor market remains stable, with initial jobless claims falling by 22,000 to 187,000 last week, the lowest since 1969 and well below the market expectation of 212,000. Continuing claims decreased by 2,000 to a seasonally adjusted 1.796 million. The Atlanta Fed's GDPNow model held its real-time Q2 GDP forecast steady at 1.7%.

Bob Schwartz, senior economist at Oxford Economics, said the extremely low initial claims data directly reflects low corporate layoff rates and a resilient labor market. "In a tight labor supply environment, solid job growth in nonfarm payrolls suggests that continuing claims will likely fall further in the coming weeks," he noted.

Treasury yields rose across the board, driven by escalating US-Iran tensions and a sharp increase in oil prices. Compared to last Friday's close, the two-year yield, which is closely tied to rate expectations, rose about 10 basis points to 4.311%, a new high since December 2024. The benchmark 10-year yield surged 14 basis points to 4.68%.

BMO Capital Markets stated that the rebound in oil prices, combined with new tariff increases, significantly complicates the task for central banks globally. These two negative factors will weigh on markets ahead of the Fed's meeting next week. The CME FedWatch Tool shows the probability of the Fed holding rates steady next week has fallen to 62% from 87% a week ago. The probability of a 25-basis-point rate hike has surged to 38% from 13%, with markets now pricing in a rate hike as early as September.

Schwartz added that the renewed surge in energy prices poses upside risks to short-term inflation forecasts. This environment will likely force the Fed to adopt a more hawkish tone overall, but he does not expect a rate hike at the July meeting, especially given the volatile geopolitical situation in the Middle East. "Tightening financial conditions can alone substitute for some rate hikes, helping to curb inflation," he said.

Market on Edge

Last week, US stocks fell broadly, with the Nasdaq and S&P 500 both declining for a second consecutive week. This was pressured by mixed corporate earnings and ongoing concerns over the US-Iran conflict. According to Dow Jones Market Data, the energy sector led all 11 S&P 500 sectors, rising 3.8% for the week, driven by higher oil prices from Middle East tensions. Utilities gained 2.5%, while industrials, real estate, and materials all rose more than 1%. Healthcare, technology, and financials saw modest gains.

Three sectors ended the week lower, led by tech and consumer stocks. Communication services fell the most, dropping 6.2% for the week. Consumer discretionary fell 6.1%, and consumer staples declined 1.4%. Alphabet, Google's parent company, plunged 7.8% for the week, hit by an 890 million euro fine from the European Commission under the Digital Markets Act and a negative free cash flow report. Tesla suffered a sharp 17% weekly drop, the worst among S&P 500 components, after its Q2 adjusted earnings per share missed market expectations.

Charu Chanana, chief investment strategist at Saxo Bank, noted that "US mega-cap tech companies will face more intense scrutiny. They are the source of huge capital expenditures, while chipmakers, storage suppliers, and computing infrastructure companies sit upstream in the AI investment chain, securing orders and revenue earlier."

Charles Schwab commented that the tech sector's weakness this week was sparked by the sell-off in Alphabet's shares after its earnings report, which included a significant upward revision to its capital expenditure guidance, reversing market optimism. While demand for computing power remains strong, the market is increasingly worried about the potential risks of unlimited expansion by hyperscale cloud providers.

Beyond the Iran conflict, next week is packed with major data releases. The Fed's rate-setting meeting runs from July 27-28, the core PCE price index—the Fed's preferred inflation gauge—is due, and four of the "Magnificent Seven" tech stocks—Amazon, Apple, Meta, and Microsoft—will report earnings. Analysts generally expect Amazon, Meta, and Microsoft to raise their capital expenditure guidance. Given the market's negative reaction to Google's report this week, these four reports carry significant downside risk.

Charles Schwab believes that with the S&P 500 breaking below its 50-day moving average, the technical outlook is bearish. Combined with multiple uncertainties, market volatility is likely to increase significantly. The firm advises investors to closely monitor oil prices and Treasury yields.