U.S. Treasury yields have retreated rapidly from elevated levels, as the two forces that had jointly driven rates higher—the AI investment boom and energy price shocks—are now diverging. Goldman Sachs warns that markets face greater uncertainty in judging the Fed's policy path, and whether or not a December hike occurs could trigger a fresh repricing of risk.
On Thursday, the 10-year Treasury yield fell 17 basis points in a single day, the largest one-day drop since March 2023, and slipped back below 5%. Goldman Sachs fixed income, currencies and commodities strategist Cosimo Codacci-Pisanelli noted in a latest report that the very AI trade that had previously pushed rates higher is now driving yields lower. As AI stocks came under selling pressure, capital flowed back into long-duration Treasuries, the stock-bond correlation reversed, and bonds once again became a hedging tool for equity investors.
But this does not mean upside rate risks have been removed: Treasury supply pressure from AI capital expenditure and debt financing still exists, and energy prices and inflation trends make the Fed's next move even harder to predict. Goldman Sachs still treats a December hike as its base case, but believes the market will struggle to easily reprice a full 25 basis point increase. Meanwhile, the interaction between AI growth prospects, energy shocks and bond supply-demand is shifting, and the market must both guard against deteriorating growth expectations and not ignore tightening risks from persistently high inflation.
AI Trade Reversal, Treasuries Regain Safe-Haven Bids
Codacci-Pisanelli attributes the recent decline in Treasury yields to three factors: high rates are beginning to weigh on AI-related assets; tail risks of a sharp slowdown in AI-driven growth have risen somewhat; and the stock-bond correlation has changed, with long-duration Treasuries once again playing a role in hedging equity risk.
This shift contrasts with the situation earlier this month when U.S. inflation data ran hot and stocks and bonds fell in tandem. Nomura strategist Charlie McElligott also previously noted that as the market reassesses AI-driven growth prospects, bonds have 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 risks.
Previously, Goldman Sachs warned that credit markets could remain calm until the wave of debt financing driven by AI capital expenditure restarts. Now, the pullback in AI stocks and widening credit spreads are testing this growth model that relies on continuous financing and capital expenditure expansion.
However, Goldman Sachs cautions that short-term fund flow changes are not enough to reverse the structural supply-demand pressures in the Treasury market. It estimates that AI capital expenditure will reach about $1.6 trillion by 2027, with debt financing accounting for a rising share. 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 Treasuries, but sustained buying still requires a broader stock market decline or further deterioration in growth expectations.
December Hike Remains Goldman's Base Case, but Market Pricing Struggles to Keep Up
Before the Fed's October meeting, despite hot inflation data, market expectations for a hike this month had cooled significantly. Goldman strategist Codacci-Pisanelli noted that inflation provided justification for a hike, but Fed Chairman Warsh had previously refused to give clear guidance on subsequent rate decisions, and the market gradually leaned toward the Fed pausing in October and leaving policy adjustment to December.
Goldman Sachs still treats a December hike as its base case, but believes it will be difficult for the market to fully reprice a 25 basis point increase. As stock market volatility intensifies, investors need to weigh the further impact of a hike on risk assets against the risk that economic and financial conditions may deteriorate accordingly.
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 hike is already largely reflected in prices, the future policy path still carries considerable uncertainty. Goldman's judgment is that how the Fed proceeds next remains extremely difficult to predict.
This also means that falling Treasury yields do not equal rates having peaked. If an AI investment slowdown drags down growth expectations, 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.
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