US Treasury yields have retreated rapidly from their highs, and the two forces that once jointly pushed interest rates higher—the AI investment boom and energy price shocks—are now diverging. Goldman Sachs warns that the market faces greater uncertainty in judging the Federal Reserve's policy path, and whether or not a December rate hike occurs, it 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 it 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 yields lower was precisely the AI trade that had previously helped push rates upward.
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 risk of rising rates has been lifted: the supply pressure on US Treasuries from 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 sees 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, energy shocks and bond supply-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.
AI trade reverses, US Treasuries regain safe-haven bids
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; and the stock-bond correlation has changed, with long-duration US Treasuries once again playing a role in hedging equity risk.
This shift contrasts with the situation earlier this month when US inflation data came in hot and stocks and bonds fell together. Charlie McElligott, a strategist at Nomura Securities, also previously noted that as the market reassesses AI-driven growth prospects, bonds have once again become a portfolio hedging tool.
At the same time, AI-related credit spreads have widened to their widest level of the year, drawing more attention to financing risk. Previously, Goldman Sachs warned that the credit market could remain calm until the 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 expanding capital expenditure.
However, Goldman Sachs cautions that short-term shifts in capital flows are not enough to reverse the structural supply-demand pressure in the US Treasury market. AI capital expenditure is expected to reach about $1.6 trillion by 2027, and the share of debt financing is also rising. As long as the AI investment outlook does not substantially collapse, related financing demand could 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.
December hike remains Goldman Sachs' base case, but market pricing struggles to keep up
Before the Fed's October meeting, despite hot inflation data, market expectations for a rate hike this month had cooled considerably. Goldman Sachs strategist Codacci-Pisanelli noted that inflation readings provided grounds for a 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 pause in October and leave policy adjustment to December.
Goldman Sachs still treats a December rate hike as its base case, but believes it will be hard for the market to fully price in another 25 basis point hike. 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 about a 90% probability 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, the future policy path remains highly uncertain. Goldman Sachs' judgment is that how the Fed proceeds next remains extremely difficult to predict.
This also means that falling US Treasury yields do not equal rates having peaked. If an AI investment slowdown drags down growth expectations, US Treasuries may continue to benefit from safe-haven demand; but if energy prices stay elevated and inflation remains slow to fall, policy rates and bond supply could still push yields higher.
Comments