U.S. Treasury yields have retreated sharply from their highs, and the two forces that once jointly pushed interest rates higher—the AI investment boom and the energy price shock—are now diverging. Goldman Sachs warns that the market faces greater uncertainty in judging the Federal Reserve's policy path, and that whether the Fed hikes or holds in December, it could trigger a fresh reassessment of risk.
On Thursday, the 10-year U.S. Treasury yield fell 17 basis points in a single day, the largest one-day drop since March 2023, and fell back below 5%. Goldman Sachs fixed income, currency and commodities strategist Cosimo Codacci-Pisanelli noted in a latest report that what drove yields lower was precisely the AI trade that had previously helped push rates up. As AI stocks came under selling pressure, capital flowed back into long-duration U.S. Treasuries, the stock-bond correlation reversed, and bonds once again became a tool for equity investors to hedge risk.
But that does not mean the upside risk to rates has been removed: the Treasury supply pressure 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 hike as its base case, but believes the market will struggle to easily price in a full 25 basis point hike again. At the same time, the interaction between 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 from persistently high inflation.
AI trade reverses, Treasuries regain safe-haven bids
Codacci-Pisanelli attributes the recent decline in Treasury yields to three factors: high rates are starting 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 Treasuries once again playing the role of hedging equity risk. This change contrasts with the situation earlier this month, when U.S. inflation data came in hot and stocks and bonds fell together. Nomura strategist Charlie McElligott also previously noted that as the market reassesses AI-driven growth prospects, bonds have once again become a portfolio hedge. Meanwhile, 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, which relies on continued financing and expanding capital expenditure.
However, Goldman Sachs cautions that short-term shifts in fund flows are not enough to reverse the structural supply-demand pressure in the Treasury market. It estimates that AI capital expenditure will reach about $1.6 trillion by 2027, with the share of debt financing also rising. As long as the AI investment outlook does not collapse substantially, related financing demand could still translate into bond supply pressure. Outflows from AI stocks can temporarily support Treasuries, but sustained buying still requires a broader stock market decline or a further deterioration in growth expectations.
A December hike remains Goldman Sachs' base case, but market pricing may struggle to keep up with the Fed
Before the Fed's October meeting, despite hot inflation data, market expectations for a hike this month had cooled significantly. Goldman Sachs strategist Codacci-Pisanelli pointed out that inflation performance provided a basis 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 regards a December 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 about a 90% chance of a December hike, and about 2.7 cumulative hikes through September 2027. Although a rate hike has already been reflected in prices to a considerable extent, the future policy path still faces significant uncertainty. Goldman Sachs' judgment is that how the Fed moves next remains extremely difficult to predict. That also means a pullback in Treasury yields does not equal a peak in rates. If AI investment slows and drags down growth expectations, Treasuries may continue to benefit from safe-haven demand; but if energy prices remain elevated and inflation stays stubbornly high, policy rates and bond supply could still push yields higher.
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