The Fed's narrow path

Summary

Last week in markets

Markets ended a volatile week as investors shifted away from AI-linked equities. The S&P 500 Total Return Index declined 0.86%, falling from Monday’s close of 17,256.24 to 17,107.06 on Friday. Thursday marked the week’s sharpest sell-off, as Meta’s expanded capital spending plans and issuance of nonvoting shares renewed concerns about the financing burden and potential returns associated with AI investment. The Nasdaq Composite fell 2.6% that session, while semiconductors declined 6.7%. Demand for Treasurys strengthened as equities weakened. The 10-year Treasury yield ended Friday at 5.00%, down 15 basis points from Monday’s close of 5.15%.

Rising energy prices added another challenge to the disinflation outlook. Brent crude climbed 6.5%, from $109.55 on Monday to $116.72 on Friday, following attacks on Saudi energy infrastructure and renewed concerns about potential U.S. and Israeli strikes against Iran. Higher oil prices extended Friday’s market weakness beyond technology stocks and raised concerns that increased fuel costs could delay progress on inflation. While the technology sell-off supported demand for Treasurys, rising oil prices simultaneously increased the prospect of tighter monetary policy. By week’s end, investors faced a central question: Can elevated equity valuations hold up against high financing costs and renewed inflationary pressure from energy prices?

The week ahead

The Federal Reserve’s October 27-28 meeting will be the first major test for markets. A Reuters poll found that 94 of 100 economists expect the Fed to hold its target range at 3.75% to 4.00%, following September’s increase. With no new economic projections scheduled, Fed Chair Kevin Warsh’s press conference will take on greater significance. Investors will look for signals on whether the Federal Open Market Committee supports expectations for another rate increase in December, recognizes the tightening already delivered by higher long-term Treasury yields, or places greater emphasis on softer hiring conditions. While markets widely anticipate a hold, guidance on the Fed’s next move could materially shift Treasury yields and the dollar.

Thursday brings the advance estimate of third-quarter gross domestic product (GDP) and September personal income and outlays data, both scheduled for release at 8:30 a.m. ET. The Atlanta Fed’s latest GDPNow estimate points to 3.5% annualized growth, suggesting economic activity remains resilient despite higher financing costs. However, the personal consumption expenditures (PCE) data will likely carry greater significance for monetary policy. Investors will assess whether core inflation remains elevated and whether higher energy costs are spreading into services prices and inflation expectations. Strong growth alongside persistent inflation would strengthen the case for another rate increase in December. Conversely, weaker demand and contained core inflation would support the view that current monetary restraint is sufficient.

Global central bank decisions and geopolitical developments round out an unusually busy week. The Bank of Canada is expected to raise its overnight rate by 25 basis points on Wednesday, while the European Central Bank (ECB) on Thursday and the Bank of Japan on Friday are widely expected to leave rates unchanged.

Israel’s October 27 election comes amid escalating regional tensions and renewed concerns about potential strikes involving Iran. Any disruption to Gulf energy production or shipping could intensify the oil price shock and push inflation expectations higher.

Corporate earnings will provide another important test for markets. Results from Microsoft, Alphabet and Amazon will offer insight into whether cloud growth and cash generation can support the scale of ongoing AI investment.