10-year Treasury yield approaches 5%, US stocks pull back: Goldman Sachs turns bullish against the tidean "insurance hike" or the restart of a tightening cycle?

Title context: 10-year Treasury yield approaches 5%, US stocks pull back: Goldman Sachs turns bullish against the tidean "insurance hike" or the restart of a tightening cycle? Text: This week, the biggest suspense at the Federal Reserve's policy meeting may no longer be whether to raise rates. CME FedWatch data shows that after the August CPI report was released, the market's pricing for a 25-basis-point rate hike in September jumped from about 70% previously to close to 90%, and as of publication it remained above 86%. Goldman Sachs chief US economist David Mericle directly changed his tune in a research note last Friday, shifting from his previous forecast of "holding steady" to expecting a 25-basis-point rate hike in September, and his wording was also blunt: "With the market already pricing in a near-90% probability of a hike, if the Fed chooses to hold steady, it is likely to trigger violent market volatility." Earlier, TD Bank and JPMorgan, which had still been hesitating, also changed course. KPMG chief economist Diane Swonk summed up the current market consensus in one sentence: "The question is no longer whether they will raise rates, but how much they need to raise rates to contain inflation." So what is the remaining 10% probability betting on? It is betting on whether Fed Chair Warsh can find a self-consistent path between "hawkish rhetoric" and "actual action." The "surface" and "substance" of the inflation data The August CPI data made it hard for the market to continue telling the story that "inflation is continuing to fall." The headline numbers do not look too bad - CPI rose 3.4% year over year, in line with expectations, and core CPI even fell to 2.4% year over year, the lowest since March 2021. But the devil is in the month-over-month details. Core CPI rose 0.3% month over month, above the expected 0.2%, and was the strongest monthly increase since April. A breakdown is even more unsettling. Housing prices rose 0.3% month over month, communication services prices surged 2.3%, and airfares soared 2.7%. Wireless phone service prices jumped 5.94% in a single month, setting a record - Inflation Insights' Omair Sharif estimates that this item alone contributed 10 basis points to core CPI. This is no longer just energy prices "carrying the load alone"; the scope of price increases is spreading to broader areas. According to estimates by Capital Economics chief North America economist Stephen Brown, based on CPI and PPI data, the core PCE deflator, which the Fed watches most closely, will rise 0.28% month over month in August, enough to push core PCE year over year from 3.3% to 3.4%, far above the 2% target. Brown's judgment is blunt - "The policy option of raising rates is likely to gain broad support within the FOMC." Combined with the August PPI released earlier last week, which rose 5.4% year over year, above the expected 5.3%, and Brent crude surging above $109 per barrel due to the Middle East situation, upward inflation pressure can no longer be brushed aside with the word "transitory." Warsh's "major test" of credibility This meeting carries unusual weight for Warsh. The new Fed chair, who took office only in May this year, was quite hawkish in his first appearance at Jackson Hole at the end of August. He said at the time that although summer inflation data was better than expected, "that does not tell me that the underlying trend has meaningfully improved," and that if policymakers fail to gain confirmation that inflation is moving back toward the 2% target, they "still have work to do." But Warsh also refused to give a specific "reaction function" and did not make clear whether a September hike was needed. "I stand here today committing to a discipline, not to a decision." This wording triggered a subtle reaction in the market. Inflation Insights' Sharif wrote in a note to clients: "For the Fed, it is now time to put up or shut up." Sharif's meaning is straightforward - Warsh cannot give a speech like the one at Jackson Hole and then fail to support a rate hike at the following meeting. Economists Anna Wong and Andrew Sacher also said bluntly that if the Fed does not raise rates, Warsh's credibility in the eyes of market participants will be completely destroyed. This pressure did not come out of nowhere. Warsh's press conference after the July policy meeting failed to satisfy investors. Citi Wealth head of portfolio strategy JP Coviello said: "The market is still somewhat worried about the Fed's independence." In other words, this meeting is not just a rate decision, but also a market pricing of Warsh's personal credibility. The tug-of-war between bulls and bears in US stocks With rate-hike expectations heating up, US stocks have clearly felt the pressure. The S&P 500 is still up nearly 12% year to date, but it has recently pulled back for consecutive sessions and is now about 2% below its mid-August record high. What has made investors most wary is the move in the bond market - the 10-year Treasury yield touched 4.99% at one point, approaching the "psychological line" of 5%. Institutions including JPMorgan and Barclays had previously warned that a 10-year Treasury yield reaching 5% would make investors significantly more cautious about the outlook for stocks. State Street macro multi-asset strategist Cayla Seder said: "We are in a period full of uncertainty. Yields are rising, rate-hike expectations are rising... the market needs to price in the overall sense of tension." But not everyone is bearish. Goldman Sachs' latest research note on September 11 offered a contrarian judgment: rising rates do not equal falling US stocks; earnings growth is the key to a bull market. Goldman's argument is that the "yield gap" between the S&P 500 earnings yield (5.2%) and the real 10-year Treasury yield (2.6%) is currently 270 basis points and has remained fairly stable over the past two years, meaning the allocation value of stocks relative to bonds has not systematically deteriorated. Goldman also reviewed data from seven rate-hike cycles over the past several decades: within three months after the start of a hiking cycle, the S&P 500 delivered an average return of -2%, with only a 29% probability of positive returns; but within 12 months after the start of a hiking cycle, the S&P 500 delivered an average return of +9%, with positive returns every time except 2022. The 1997 case is especially instructive - the Fed raised rates by only 25 basis points, the S&P 500 promptly fell 10%, but once the market stopped pricing in further tightening, stocks bottomed out, rebounded, and hit a new high within three months. The logic behind this historical pattern is actually not complicated: the medium-term impact of rate hikes on stocks ultimately depends on how monetary tightening affects earnings growth. As long as corporate earnings continue to grow, the damage from valuation compression is limited. But Goldman also warned that about 75% to 80% of the S&P 500's present value comes from cash flows more than 10 years out, which means stock valuations are far more sensitive to long-end rates than to short-end rates, and rate volatility itself is an additional source of risk. Will a single hike start a new rate-hike cycle? If rates are indeed raised, what the market really cares about is another question: is this a one-off "insurance hike," or the beginning of a longer tightening cycle? "If it sends the signal of a cycle - for example, that we still have work to do - I do not think that is good for the market," BNY Wealth chief investment officer Alicia Levine expressed this concern. This divergence is directly reflected in bond market pricing. After the August CPI data was released, the 2-year Treasury yield rose about 4 basis points, the 10-year was roughly flat, while the 30-year actually fell 2 basis points, flattening the yield curve. This "short end up, long end down" move shows that the bond market is more inclined to interpret this hike as "the Fed taking its inflation target seriously," rather than "the start of a new tightening cycle." The upcoming FOMC statement and Warsh's press conference will become the key moment for testing this judgment. If the statement's wording is hawkish and hints at further action ahead, the market's first reaction may be further curve flattening and pressure on stocks. But if Warsh can convey a signal that "this hike is a disciplined response to inflation data, not a full shift toward tightening," the market's tension may be alleviated. Either way, global markets are going through a delicate moment. Seder said: "If the Fed does not raise rates and the market rallies because of that, I think that could be an opportunity to trim positions. Because there is another possibility - they do not move in September, but they may move at some point later." This feeling of unresolved suspense may make investors more uneasy than the rate hike itself.