The Fed policy outlook has become the key near-term variable for U.S. equities

Overview

This issue of US Weekly Kickstart focuses on the impact of the Fed policy path on the U.S. equity market. The report notes that the start of Q2 earnings season and the upcoming CPI release will together be key market themes next week. Goldman Sachs economists expect June core CPI year-on-year at 0.17%, headline CPI at -0.11%, and expect the Fed to keep policy rates unchanged this year; however, market pricing has clearly turned hawkish, reflecting expectations for roughly 50 bps of hikes by mid-2027.

Core views

The core view is that earnings growth should still determine the medium-term direction of U.S. equities, but if the Fed actually hikes rates, U.S. equities could face short-term pressure. The reasons include: tightening compresses growth expectations; the AI investment wave makes this cycle more capital-intensive and more sensitive to the cost of capital; and historically, high-valuation, high-concentration bull markets often peak or feel pressure under a Fed tightening backdrop. At the same time, if CPI data or policy communication causes a dovish repricing of rate expectations, the current hawkish pricing could translate into a short-term upside catalyst for equities.

Analysis framework

The report combines macro policy expectations, historical hiking-cycle backtests, options-implied volatility, rate-sensitive stock baskets, AI infrastructure capital expenditure, S&P 500 valuation models, sector relative performance, and internal market indicators to assess the potential impact of Fed policy changes on the index, sectors, style factors, and stock baskets.

Methodology notes

• macro strategyFed policy scenario analysis

  Compare economist base forecasts, market rate pricing, and implied probabilities from options to identify S&P 500 sensitivity to hike, hold, or dovish shift scenarios.

  The report uses Fed funds rate pricing, CPI expectations, and the FOMC path to explain how markets reprice policy uncertainty.

• historical backtestEarly-stage hiking-cycle stock return analysis

  Compare 3-month and 12-month S&P 500 performance after the first hike in past Fed hiking cycles.

  The report states that in the past seven hiking cycles the average S&P 500 return after the first hike over 3 months was about -2%, while the 12-month average return was about 9%, with all cycles positive except 2022.

• valuation modelMacro S&P 500 P/E model

  Estimate the impact of rising rate volatility on equity valuation multiples.

  The report says that if rate volatility rises to the level of the previous 2022-2023 hiking cycle, it could imply about a 6% drop in the S&P 500 P/E, or roughly one valuation step.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• S&P 500

  Core research subject

  Strengths

  Earnings growth remains the primary driver of medium-term direction, and average 12-month returns after past hiking cycles are still positive.

  Weaknesses

  History shows weaker performance in the early phase of hiking cycles, and high valuation and concentration increase sensitivity to policy shocks.

  Comparison

  At the index level, exposure is comprehensive across Fed policy, AI capex, and concentration in large-weighted stocks, relative to single-sector or single-stock baskets.

  Risks

  CPI surprise, Fed turning hawkish, rising rate volatility, and downward revisions to growth expectations.

• Info Tech

  Sector with relatively better historical performance in early hike-expectation phases

  Strengths

  Has shown relatively consistent excess performance in similar scenarios, supported by the AI investment theme.

  Weaknesses

  AI capex cycle is capital intensive, making it more sensitive to rising capital costs.

  Comparison

  The report says that in historical rate-pricing phases, Info Tech and Financials were the two sectors with the most consistent relative performance direction.

  Risks

  Rising financing costs, AI capex returns below expectations, valuation compression.

• Financials

  Sector with relatively weaker historical performance in early hike-expectation phases

  Strengths

  In theory, higher rates could support some net interest margins, but the report does not treat this as a primary positive conclusion.

  Weaknesses

  Historical backtests show it performed the weakest in relative terms after markets first priced in hikes.

  Comparison

  Unlike Info Tech's relative resilience, Financials have shown more consistently weak outcomes in historical samples.

  Risks

  Rate volatility, slowing growth, credit-cycle stress.

• Stocks with weak balance sheets and high-rate debt

  Most sensitive basket to Fed policy expectations

  Strengths

  If rate expectations turn dovish, they may benefit from relief-rally elasticity.

  Weaknesses

  Recently negatively correlated with the 2-year Treasury yield, and higher rates can pressure valuation and financing conditions.

  Comparison

  Compared with stocks with stronger balance sheets, these names are more sensitive to short-end rates and the financing environment.

  Risks

  Rising hike expectations, widening credit spreads, refinancing pressure.

• AI Infrastructure and Hyperscalers

  Capital-intensive thematic exposure

  Strengths

  High shares of S&P 500 market value and earnings make them meaningful support for earnings growth.

  Weaknesses

  Capex is near high levels relative to free cash flow, with rising debt and equity financing needs.

  Comparison

  Compared with traditional light-capital industries, this theme has more direct exposure to changes in capital costs.

  Risks

  Higher funding costs, pressure from debt issuance requirements, AI capex upside revisions weaker than Q1.

Key data

• Economists' forecast for June core CPI month-on-month0.17%Below market consensus expectations of around 0.2%.
• Economists' forecast for June headline CPI-0.11%Reflects recent declines in energy prices.
• Market-embedded near-term Fed hike probabilityabout 35%Probability of a hike around the July FOMC meeting.
• Market-embedded projected Fed hikes by mid-2027about 50 bpMarket is more hawkish than Goldman Sachs economists' base case.
• Goldman Sachs probability for Fed hike scenario25%Base forecast remains that rates stay unchanged this year.
• Past seven hiking cycles: average S&P 500 return over 3 months after first hike-2%Shows hikes are generally unfavorable for stocks in the early phase.
• Past seven hiking cycles: average S&P 500 return over 12 months after first hike9%12-month returns were positive in all cycles except 2022.
• S&P 500 drawdown around the single 25 bp hike in 1997about -10%Cited as a historical example that even mild hikes can pressure equities.
• Average absolute S&P 500 volatility on CPI release days over the past year0.6%Close to normal average volatility.
• Options-implied S&P 500 volatility for next Tuesdayabout 0.8%Total implied volatility before Friday is about 1.1%.
• AI infrastructure stocks as a share of S&P 500 market value42%Indicates high exposure of the index to the AI capex cycle.
• AI infrastructure stocks as share of 2026 S&P 500 EPS38%Consensus estimate methodology.
• Hyperscaler net debt$239 billionQ1 data, up about 190% year over year.
• 2026 USD IG total supply forecast$2.1 trillionGoldman Sachs credit strategists see upside risk.
• Q2 U.S. equity issuance size$252 billionHigher than the 2021 Q1 record of $234 billion.

Impact & implications

For asset allocation, the report suggests that the short-term risk-return profile of U.S. equity indices is increasingly dependent on policy repricing from CPI and Fed communication. If hike expectations heat up, valuations, balance-sheet-constrained stocks, capital-intensive AI infrastructure chains, and high-valuation, highly concentrated markets may come under pressure; if data pushes a dovish shift, current hawkish pricing could release room for a rebound. At the industry level, historical experience suggests Info Tech tends to perform relatively better in similar phases while Financials underperform, but the report emphasizes that the most critical macro variable remains the health of growth expectations.

Risks

• Actual Fed rate hikes or policy communication turning hawkish compressing equity valuations.
• CPI above expectations, leading markets to price a more restrictive path.
• Higher rate volatility, even without Fed hikes, may still compress equity valuations.
• AI infrastructure and hyperscaler capex financing needs raise sensitivity to funding costs.
• High valuation and high concentration in the market make it historically more likely for a bull market top to emerge in a Fed tightening phase.
• Deterioration in growth expectations could amplify the negative impact of hike pricing on equities.

What to watch

• Next Tuesday's CPI print, especially whether core CPI is near or below the 0.17% month-over-month forecast.
• Whether the July 28-29 FOMC meeting and Fed communication confirm a hold or signal hike risk.
• Whether market pricing of the Fed path to mid-2027 continues to hold around 50 bps of hikes.
• In Q2 earnings season, bank and mega-tech guidance on earnings, AI capex, and financing demand.
• Co-movement of the 2-year U.S. Treasury yield, rate volatility, and S&P 500 P/E.
• Relative performance of the basket sensitive to weak balance sheets, high-rate debt, and high-yield debt.
• Whether S&P 500 market breadth, concentration, stock correlation, and options-implied volatility are changing.