Goldman Sachs Warns: Whether the Fed Hikes in December or Not, Markets May Be Unprepared

US Treasury yields have rapidly retreated from their highs, and the two forces that had jointly pushed rates higher—the AI investment boom and the energy price shock—are now diverging. Goldman Sachs warns that the market's judgment of the Federal Reserve's policy path faces greater uncertainty, and whether or not there is a rate hike in December could trigger a new repricing of risk.

On Thursday, the 10-year US Treasury yield fell 17 basis points in a single day, the largest one-day drop since March 2023, and fell back below 5%. Cosimo Codacci-Pisanelli, a strategist in Goldman Sachs' fixed income, currencies and commodities division, noted in a latest report that what drove the yield decline was precisely the AI trade that had previously helped push rates higher.

As AI stocks came under selling pressure, capital flowed back into long-duration US Treasuries, the stock-bond correlation reversed, and bonds once again became a tool for equity investors to hedge risk. But this does not mean the upside risk to rates has been lifted: the US Treasury supply pressure brought by AI capital expenditure and debt financing still exists, and energy prices and inflation trends also make the Fed's next move harder to predict.

Goldman Sachs still treats a December rate hike as its base case, but believes the market will find it difficult to easily price in a full 25 basis point hike again. At the same time, the interaction among AI growth prospects, the energy shock and bond supply and demand is changing, and the market must both guard against a deterioration in growth expectations and not ignore the tightening risk brought by persistently high inflation.

Codacci-Pisanelli attributes the recent decline in US Treasury yields to three factors: high rates are beginning to weigh on AI-related assets; the tail risk of a sharp slowdown in AI-driven growth has risen somewhat; and the stock-bond correlation has changed, with long-duration US Treasuries once again playing a role in hedging equity risk.

This change contrasts with the situation earlier this month when US inflation data came in hot and stocks and bonds fell in tandem. Nomura strategist Charlie McElligott also previously noted that as the market reassesses the AI-driven growth outlook, bonds have once again become a portfolio hedging tool.

Meanwhile, AI-related credit spreads have widened to their widest level of the year, and financing risk is drawing more attention. Previously, Goldman Sachs warned that the credit market could remain calm until a new wave of debt financing driven by AI capital expenditure restarts. Now, the pullback in AI stocks and the widening of credit spreads are testing this growth model that relies on continuous financing and capital expenditure expansion.

However, Goldman Sachs cautions that short-term capital flow changes are not enough to reverse the structural supply and demand pressures in the US Treasury market. AI capital expenditure is expected to reach about $1.6 trillion in 2027, and the share of debt financing is also rising. As long as the AI investment outlook does not substantially collapse, related financing demand may still translate into bond supply pressure. Outflows from AI stocks can temporarily support US Treasuries, but sustained buying still requires a broader stock market decline or a further deterioration in growth expectations.

A December rate hike remains Goldman Sachs' base case, but market pricing is not easily keeping up

Before the Fed's October meeting, despite hot inflation data, market expectations for a rate hike this month had cooled significantly. Goldman Sachs strategist Codacci-Pisanelli noted that the inflation performance provided a basis for a rate hike, but Fed Chair Warsh had previously refused to give clear guidance on subsequent rate decisions, and the market gradually leaned toward the view that the Fed would hold off on a hike in October and leave the policy adjustment to December.

Goldman Sachs still treats a December rate hike as its base case, but believes it will be difficult for the market to fully price in a 25 basis point hike again. As stock market volatility intensifies, investors need to weigh the further impact of a rate hike on risk assets and the risk that economic and financial conditions may deteriorate as a result.

As of October 23, Goldman Sachs data showed that the market priced in about a 90% chance of a December rate hike and about 2.7 cumulative hikes through September 2027. Although a hike is already reflected in prices to a considerable extent, there is still significant uncertainty about the future policy path. Goldman Sachs' judgment is that how the Fed moves next remains extremely difficult to predict.

This also means that the decline in US Treasury yields does not equal a peak in rates. If a slowdown in AI investment drags down growth expectations, US Treasuries may continue to benefit from safe-haven demand; but if energy prices remain high and inflation stays stubbornly elevated, policy rates and bond supply could still push yields higher. Risk disclosure and disclaimer

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