Goldman Sachs Warns: Markets Unprepared for Fed’s December Decision Either Way
TREE NEWS reports: Goldman Sachs has issued a stark warning that financial markets may be ill-prepared for the Federal Reserve’s next move in December, whether it raises interest rates or not. The caution comes as the 10-year Treasury yield plunged 17 basis points on Thursday — its largest single-day drop since March 2023 — falling back below the 5% threshold. The very AI trade that had previously pushed yields higher is now driving them lower, creating a complex and uncertain backdrop for investors.
The AI Trade Reversal and Its Impact on Bonds
Goldman Sachs fixed income, currency and commodities strategist Cosimo Codacci-Pisanelli noted in a recent report that the decline in Treasury yields is being driven by three factors: high interest rates are beginning to weigh on AI-related assets, tail risks of a significant slowdown in AI-driven growth have risen, and the correlation between stocks and bonds has shifted. As AI stocks sell off, capital is flowing back into long-duration Treasuries, reversing the stock-bond correlation and restoring bonds as a hedge against equity risk.
However, this does not mean that the risk of rising rates has disappeared. The supply pressure on Treasuries from AI capital expenditure and debt financing remains, and the trajectory of energy prices and inflation makes the Fed’s next steps harder to predict. Goldman Sachs estimates that AI capital expenditure will reach approximately $1.6 trillion by 2027, with debt financing accounting for a growing share. As long as the AI investment outlook does not collapse substantially, related financing needs could still translate into bond supply pressure.
December Rate Hike Still Base Case, but Market Pricing Struggles to Keep Up
Goldman Sachs maintains that a December rate hike is its base case, but believes the market will struggle to fully price in another 25 basis point increase. As of October 23, Goldman Sachs data shows the market pricing in about a 90% chance of a December hike and about 2.7 cumulative hikes through September 2027. Although a hike is largely reflected in prices, significant uncertainty remains about the future policy path. Goldman Sachs’ judgment is that the Fed’s next move remains extremely difficult to predict.
This also means that the decline in Treasury yields does not signal that rates have peaked. If AI investment slows and drags down growth expectations, Treasuries could continue to benefit from safe-haven demand. But if energy prices remain elevated and inflation stays stubbornly high, policy rates and bond supply could still push yields higher.
Key Takeaways for Investors
- Bonds are back as a hedge, but only temporarily: The reversal in stock-bond correlation means long-duration Treasuries can once again cushion equity portfolios, but structural supply pressures from AI-driven debt financing could limit the rally.
- December Fed decision is a binary risk: With markets pricing a 90% chance of a hike, any deviation — whether a pause or a larger increase — could trigger significant repricing across asset classes.
- Watch AI credit spreads: AI-related credit spreads have widened to their widest levels of the year, signaling growing financing risks that could spill over into broader markets.
- Inflation and energy prices remain wildcards: Persistent inflation or an energy price shock could force the Fed’s hand and reignite bond sell-offs, making it crucial to monitor these indicators closely.
In this environment, investors should prepare for heightened volatility and consider diversifying across assets that can perform in both inflationary and growth-slowdown scenarios. The interplay between AI growth prospects, energy shocks, and bond supply-demand dynamics is shifting, and markets must guard against both deteriorating growth expectations and the tightening risks from persistently high inflation.
