Fed Hike Odds Rise as US Equities Hold Near 10-Year Valuation Averages

Investors have significantly increased the probability of a Federal Reserve interest rate hike, with market pricing now reflecting an 84% chance of action at the upcoming FOMC meeting. This shift follows the release of August core CPI data, which showed inflation rising more than economists had estimated. Despite this hawkish repricing, Goldman Sachs maintains that the US equity market is positioned to continue its upward trajectory, citing robust corporate performance and valuation levels that remain near the 10-year average rather than being stretched.

Jonathan Shugar, head of Cross Asset Sales at Goldman Sachs, noted on The Markets podcast that the market’s reaction signals a recognition that inaction by the Fed could be riskier than a hike. The primary concern is the potential loss of control over long-term interest rates, or the "back end" of the yield curve, which is driven by market forces rather than direct central bank policy. While the Fed controls the short-term Fed funds rate, the market determines longer-term yields, creating a risk environment where a hike may be necessary to prevent volatility in long-duration assets.

Strong Q2 Earnings Support Market Resilience

The fundamental case for continued equity gains rests on second-quarter corporate results, which demonstrated strong earnings growth across sectors. Shugar emphasized that these earnings gains underpin current valuations, keeping them within a reasonable range relative to historical norms. This financial health provides a buffer against the negative sentiment associated with rising interest rates, suggesting that companies are generating sufficient cash flow to service debt and invest in growth even in a tighter monetary environment.

AI Investment Unrestrained by Rate Hikes

Contrary to the expectation that higher borrowing costs will slow technological development, Goldman Sachs argues that a Fed rate hike may not restrain investment in artificial intelligence. The sector’s growth is driven by structural demand and long-term capital allocation strategies that are less sensitive to short-term interest rate fluctuations. This decoupling allows AI-focused companies to maintain their capex plans, supporting a sustained investment cycle independent of immediate monetary policy shifts.

Consumer Stocks Present Strategic Opportunities

Shugar highlighted consumer experience stocks as a specific area of opportunity for investors navigating the current rate environment. While goods inflation has moderated, service inflation remains elevated, creating a favorable landscape for companies focused on experiential spending. The firm suggests that these sectors may outperform as consumers shift spending patterns, providing a hedge against broader market volatility linked to interest rate uncertainty.