Investors upbeat on hawkish Fed fighting inflation but remain wary of crude oil prices and AI risks

The Federal Reserve’s determination to combat inflation gives investors reason for optimism, though risks tied to oil prices and artificial intelligence prevent them from fully committing, according to Bloomberg.

Last week, the Fed restored its credibility by showing, through a hawkish message, that it was not falling behind the curve, without signalling an aggressive cycle of rate increases. The message initially calmed markets, but unease persisted on Friday as the 10-year Treasury yield again tested 5% and the S&P 500 swung between gains and losses. Oil prices have retreated, but Brent crude remains above $100 a barrel.

“It is difficult to see rates and equities fully stabilising until energy-related inflation pressures ease,” Barclays Plc strategists led by Emmanuel Cau told Bloomberg. “Nevertheless, the positive development is that Fed independence and credibility have been reaffirmed, providing clarity on its reaction function.”


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The Fed’s decision may prove to be a clearing event. Investors’ shift toward caution ahead of the policy meeting suggested they were far from complacent, with clear indications that they had reduced exposure and added hedges. Friday’s massive quarterly expiry also helped reset options positioning.

“With earnings growth robust, credit spreads contained, and the VIX subdued, US equity fundamentals remain supportive, leaving us constructive on the S&P 500 beyond near-term volatility,” said Societe Generale SA strategist Manish Kabra. The yield curve remains an important signal, and Kabra expects the benchmark to reach 8,000 by year-end, despite some volatility, provided an inversion is avoided, Bloomberg reported.

The prospect of a year-end rally remains alive, but the path may be difficult. Diesel prices point to higher inflation ahead, and unless the war in Iran is resolved quickly enough to drive oil prices significantly lower, the central bank may have little choice but to adopt an even more hawkish stance.

Swap markets are pricing in another three rate increases by the end of July. Attention will focus on the risk of a bond-market shock, as 10-year yields above 5% make Treasuries increasingly attractive. Still, as long as economic and earnings growth remain resilient, investors may hesitate to move out of equities and instead continue broadening their exposure.

Bank of America Corp. strategists led by Jared Woodard have adopted a more cautious view, arguing that positioning remains too bullish given the expected moderation in earnings next year. They said the 10%-15% growth projected for 2027 implies a sustained ISM manufacturing reading above 53. It’s “not yet time for defensives, but quality, value, and yield look prudent,” they said.

Investors have grown more sceptical about AI spending and the future returns on those investments, casting doubt on the earnings outlook across the entire chain of AI beneficiaries. At the same time, the technology sector has seen a rotation: software has regained strength, while semiconductors have largely stalled over the past two months and become increasingly volatile.

S&P 500 valuations have fallen sharply, leaving the benchmark trading just above its long-term average. Although the de-rating largely reflects surging earnings estimates, the recent pullback indicates that investors are unwilling to pay a premium for growth, whether at the index or sector level.

If caution persists in the near term, an earnings season that exceeds expectations in a few weeks could revive sentiment and risk-taking.

“The resilience suggests investors are distinguishing between higher rates driven by persistent inflation and a fundamentally deteriorating growth outlook,” said Daniela Hathorn, senior market analyst at Capital.com, Bloomberg reported. “For now, the latter has not become the dominant concern.”

(Disclaimer: This article is based on inputs from agencies. These do not represent the views of The Economic Times)