S&P 500 Poised to Absorb Fed Rate Hikes Amid AI Earnings Growth
Market pricing suggests a 71.8% probability of a Federal Reserve rate hike at the September meeting. Analysts argue that strong AI-driven earnings and a slow pace of increases will protect equity valuations.
Market pricing indicates a 71.8% probability that the Federal Reserve will raise interest rates at its September meeting. By the December meeting, investors assign a 63.5% likelihood to at least two hikes. These expectations reflect the central bank's need to address persistent inflation.
Inflation stood at 3.4% year-over-year in July. This level remains above the central bank's target. Historically, rate hikes have correlated with negative stock returns. The S&P 500 posted negative returns in the six months following the first hike in a cycle since 1994.
AI spending offsets rate hike impact
Whitney Stewart of Sterling Capital Management notes that hyperscaler AI spending drives earnings growth. S&P 500 earnings growth expectations for 2027 remain in double digits. Stewart states that this earnings momentum can counterbalance the dampening effect of higher interest rates.
LPL Financial compares the current environment to 1997. In 1997, the S&P 500 continued its rally despite Fed rate hikes. Investor optimism about the internet sector supported equity prices. The firm argues that similar optimism for AI can support markets now.
Inflation moderation allows slower hikes
Inflation has moderated from its peak of 4.2% in May. The current level of 3.4% suggests the Fed may move slowly. Data indicates that the speed of rate hikes matters for market digestion. A slower pace allows investors more time to process the changes.
A slow pace of hikes helps investors adjust their portfolios. This gradual approach reduces the shock to equity valuations. The combination of strong earnings and measured policy actions provides a supportive backdrop for stocks.
Historical context for current cycle
The 2022 rate hiking cycle raised the fed funds rate from near zero to over 5%. This rapid increase coincided with a 20% drop in the S&P 500. The current cycle involves fewer hikes and a slower pace. This difference distinguishes the current environment from the 2022 downturn.
GN markets/policy (en-US) reports that the 2026 rate hike outlook is less severe than previous cycles. The 71.8% probability for a September hike reflects a measured approach. Market participants view this as manageable given the underlying earnings strength.
