Stocks Rally Despite Rising Rate-Hike Odds. Should Investors Buy or Cut Risk?
U.S. stocks staged a seemingly counterintuitive move on Friday: CPI came in hotter than expected and the odds of a Fed rate hike next week climbed further, yet all three major indexes moved higher, led by the Nasdaq.
With a 25-basis-point hike now largely priced in, investors are shifting their focus to the path ahead: Will the Fed keep hiking after this move?
Why Are Stocks Rising Despite Hotter CPI?
First, the 10-year Treasury yield briefly approached 5% but failed to break decisively higher. For tech stocks, a sustained rise in long-term yields would add further valuation pressure. The stabilization in yields has therefore given growth stocks some room to rebound.
Meanwhile, oil prices pulled back after their recent surge, easing concerns that higher energy costs could fuel another leg higher in inflation.
The improvement in risk appetite quickly showed up in individual stocks. $Apple(AAPL)$
Still, the rally remained uneven. $SanDisk (SNDK.US)$ fell more than 3%, while $Micron Technology (MU.US)$ also edged lower. Money is moving back into tech and growth stocks, but the market has yet to show a broad-based risk-on move.
Over the past several sessions, investors have already absorbed rising oil prices, higher rate-hike expectations and the 10-year Treasury yield approaching 5%. Although today's CPI was hot, neither oil nor long-term yields moved materially higher. With macro risks at least temporarily stabilizing, previously pressured risk assets found room to rebound.
The Bigger Risk Is the Path of Future Rate Hikes
Markets have already largely priced in a 25-basis-point hike next week. The bigger question is whether the Fed signals that a second or even third hike could follow.
History offers some useful context. In 2000, the Fed continued tightening after rates had already reached 5.5%, eventually lifting them to 6.5%. High rates, further tightening and elevated tech valuations added to pressure on equities. In 2022, repeated upward revisions to the expected terminal rate drove Treasury yields sharply higher and triggered a major valuation reset in tech stocks.
By contrast, the policy rate reached 5.25%–5.50% in 2023, but stocks continued to advance as investors increasingly concluded that the tightening cycle was nearing its end.
The historical takeaway is clear: markets can absorb high rates, but repeated hikes and a continuously rising terminal-rate outlook create much greater pressure.
What Should Investors Do Now?
At this stage, investors could use the rebound to modestly reduce risk while keeping some cash available until the FOMC provides more clarity. Core long-term positions may not require major changes, but exposure to high-valuation, high-beta stocks that have already rallied sharply could be trimmed. Chasing the rally or adding leverage ahead of the Fed meeting may also carry an unfavorable risk-reward.
The two key signals to watch are the 10-year Treasury yield and expectations for further rate hikes. If long-term yields retreat after a September hike and expectations for additional tightening fade, tech stocks could have more room to recover. If markets begin pricing in a second and third hike while the 10-year yield remains above 5%, further risk reduction may be warranted.
At the stock level, investors may want to prioritize mega-cap tech companies with strong cash flow, greater earnings visibility and solid balance sheets while rate uncertainty remains elevated. Alphabet and Apple, both outperforming today, may offer relatively stronger defensive qualities, while Nvidia continues to benefit from AI-driven growth and strong earnings, though with higher volatility. Higher-beta names may become more attractive once long-term yields show clearer signs of retreating.
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