Wall Street faces Fed test as Treasury yields near 5% and oil trades above $100

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Wall Street braces for key Fed decision

Bond market pressure returns to Wall Street

U.S. stocks start the new week with the bond market becoming one of the main sources of pressure. Investor’s Business Daily reported that the 10-year U.S. Treasury yield climbed to around 4.97% last week as investors increased bets on a Fed rate hike at the September 16 meeting.

The yield is now close to the psychologically important 5% threshold. That is intensifying competition between bonds and equities, as higher yields offer investors increasingly attractive returns without taking on stock-market risk.

Technology stocks and other growth companies remain particularly sensitive to rising long-term rates as their valuations depend more heavily on future cash flows. That pressure was already evident last week: the Dow Jones fell around 1.6%, the S&P 500 declined 0.8%, and the Nasdaq lost roughly 0.7%.

Higher energy costs threaten another inflation wave

The energy market is creating another source of pressure. Oil rose 9.4% over the week and remains well above $100 per barrel amid escalating geopolitical tensions and risks of supply disruptions from the Middle East.

For the Fed, this creates an especially difficult combination. Higher oil prices directly feed into fuel inflation while also increasing transportation and production costs for companies. At the same time, rising Treasury yields are already tightening financial conditions even before any additional move from the central bank.

Pressure eased somewhat on Friday as oil prices pulled back and U.S. equity indexes recovered. The S&P 500 gained 0.9%, the Dow added 509 points, and the Nasdaq rose around 1%. Brent, however, remained above $100, leaving energy prices as one of the key risks heading into the new week.

Fed guidance could matter more than the rate hike

Investor focus is almost exclusively on the Federal Reserve. Markets are now pricing in a high probability of a 25-basis-point Fed hike, while recent inflation data have reinforced expectations that the Fed will need to keep policy restrictive.

As Traders Union previously reported, U.S. consumer prices rose 0.4% month over month and 3.4% year over year in August, while gasoline prices increased 3.9%. Following the release, the probability of a 25-basis-point Fed hike moved close to 90%.

For equities,the big question is no longer just whether the Fed will raise rates. It's also about how policymakers talk about the future. If the central bank says that high oil prices and stubborn inflation mean rates must stay high for longer, stock prices could keep feeling the pressure even after the September 16 decision.

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