According to analysis from Goldman Sachs, the US stock market could experience short-term pressure if the Federal Reserve resumes interest rate hikes, although corporate earnings are expected to remain the primary driver for long-term market direction.
The US stock market is entering a critical week as major Wall Street banks kick off the earnings season and key US inflation data is set for release, both of which could influence expectations for Federal Reserve policy. Concurrently, renewed conflict in the Middle East has driven international oil prices sharply higher, casting a shadow over the market outlook.
Goldman Sachs economists anticipate that the US core CPI for June, due Tuesday, will show a modest month-over-month increase of 0.17%, while the headline CPI is expected to decline by 0.11%, largely due to falling energy prices. The Federal Reserve's next policy meeting is scheduled for July 28-29. Market pricing currently suggests only about a one-in-three chance of a July rate hike, yet investors remain divided on the longer-term trajectory of monetary policy.
Futures markets imply nearly 50 basis points of rate hikes by mid-2027, an expectation that is more hawkish than the view held by Goldman Sachs economists. The firm's economists project the Fed will hold rates steady this year, assigning only a 25% probability to further policy tightening.
A report from Goldman Sachs dated July 10 indicated that a resumption of Fed rate hikes could pressure US equities. The report noted that higher rates could impact economic growth, the rising importance of financing costs during the AI investment boom, and historical data showing stocks typically weaken in the initial phase of a tightening cycle.
Historical patterns suggest short-term pressure but long-term resilience for US stocks. Goldman's analysis shows that in the three months following the start of the past seven Fed hiking cycles, the S&P 500 index declined by an average of approximately 2%. However, over time, the market generally recovered; with the exception of 2022, the benchmark index delivered positive returns over the 12 months following each rate hike.
Goldman pointed to 1997 as a typical example of a modest tightening cycle. Although the Fed raised rates only once by 25 basis points, the S&P 500 fell about 10% around the hike before rebounding to new highs within three months.
The firm also noted that recent shifts in market expectations for future hikes have historically pressured equities. Since 1995, the average and median returns for the S&P 500 have been close to zero in the three months after the market began pricing in at least a 25-basis-point Fed hike.
Sector-wise, information technology stocks have historically performed best when markets begin anticipating monetary policy tightening, while financial stocks have tended to lag. Companies with weaker balance sheets, higher levels of floating-rate debt, or greater sensitivity to high-yield financing are particularly vulnerable to changes in rate expectations.
The report highlighted that the current market may be especially sensitive to borrowing costs due to massive spending on AI infrastructure. Goldman estimates that by 2026, AI-related companies will account for 42% of the S&P 500's market capitalization and 38% of its estimated earnings per share. The significant increase in debt issuance and capital expenditure by hyperscale tech firms has elevated the importance of capital costs beyond previous cycles.
Even if the Fed holds rates steady, Goldman warned that increased interest rate volatility could pose another challenge for stocks. Historically, equity performance has tended to be weaker during periods of significant volatility in US Treasury yields, and heightened rate volatility is typically associated with lower market valuations.
Goldman estimates that if US Treasury volatility reverts to levels seen during the Fed's 2022-2023 tightening cycle, the S&P 500's price-to-earnings ratio could decline by approximately 6%.
However, the firm noted that if inflation data comes in weaker than expected, shifting investor expectations toward a more dovish Fed policy, current market pricing still leaves room for a rebound. Options markets imply the S&P 500 could move about 0.8% around the CPI release, with a potential weekly move of around 1.1%.
Despite near-term uncertainties, Goldman Sachs maintains its optimistic earnings forecasts, projecting S&P 500 EPS to reach $340 by 2026 and a year-end index target of 8000, implying roughly 6% upside from current levels.
Fed officials set for a busy week of commentary as economic data, earnings season, and Middle East tensions continue to unsettle markets. New Fed Chair Kevin Warsh is scheduled to make his first appearance before Congress on Tuesday, July 14, the same day the US CPI report is released. Markets will watch closely for any signals from Warsh regarding the July rate decision.
Additionally, several other Fed officials, including Governor Christopher Waller, New York Fed President John Williams, Governor Lisa Cook, and Vice Chair Philip Jefferson, are slated to deliver speeches throughout the week.
Goldman Sachs interest rate strategists believe that as Chair Warsh establishes a new communication framework, there is upside risk to interest rate volatility around the next several FOMC meetings. Regardless of whether the Fed ultimately raises rates, uncertainty surrounding the future path of interest rates is likely to weigh on the US stock market.
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