Original author: Xu Chao

Original source: Wall Street Watch

Expectations for a Federal Reserve interest rate hike suddenly intensify, the bank earnings season officially opens, and the new chair makes her first appearance at Congress—these three variables overlap within the same timeframe, making this Tuesday the most decisive day for the market in recent times.

On this Tuesday, the U.S. June CPI data will be released at 8:30 AM Washington time, followed by Federal Reserve Chairman Kevin Waller’s first appearance at a House Financial Services Committee hearing as the new chair. Additionally, JPMorgan Chase, Bank of America, Wells Fargo, Goldman Sachs, and Citigroup will all report their second-quarter earnings, marking the start of this earnings season. Ian Lyngen, head of U.S. rate strategy at BMO Capital Markets, stated, "The combination of the CPI data and Waller's testimony will significantly shift the odds of a rate hike in one direction."

Federal Reserve Governor Christopher Waller clearly defined the triggers for a rate hike on Monday, stating that if this week's core inflation data shows "elevated levels again," the FOMC will need to consider tightening monetary policy in the near term. This statement quickly reshaped market pricing: the implied probability of a rate hike in July surged from below 10% to about 50%, and the two-year U.S. Treasury yield reached 4.28%, the highest level in over a year. Meanwhile, the geopolitical tension between the U.S. and Iran escalated again, with Brent crude oil prices jumping nearly 10% in one day, putting double pressure on inflation expectations.

In terms of earnings, Goldman Sachs expects that the second-quarter earnings growth of the S&P 500 will reach 22% year-on-year, with AI infrastructure-related stocks expected to contribute around 50% of the overall earnings growth. However, Goldman also warned that if the Federal Reserve initiates a rate hike cycle, the resulting pressures on growth expectations, increased capital costs, and the historical fragility of overvalued markets could pose three significant obstacles to U.S. stocks.

CPI Forecast: Energy Weighs on Overall, Core Inflation Remains the Core Conflict

The market generally expects that the June CPI will show a month-on-month decrease of about -0.2%, while the year-on-year figure is expected to slow from 4.2% in May to 3.8%, marking the first monthly decline since the outbreak of the pandemic in 2020, driven primarily by falling gasoline prices—regular gasoline prices dropped approximately 15% from mid-May to the end of June.

Goldman Sachs predicts an overall CPI month-on-month rate of -0.11% and a core CPI month-on-month rate of 0.17%, lower than the market average expectation of 0.2%. Goldman economists point out that the potential for inflation improvement in the coming months stems from several factors: airline ticket prices will decline as jet fuel prices fall; hotel prices—measured by booking prices—will revert from the highs during the World Cup; and rent inflation will continue to slow.

However, the improvement rate of core PCE inflation is expected to lag behind that of core CPI. Goldman predicts that the average monthly increase of core PCE in the next three months will be about 0.23%, partly due to the upward pressure on financial services implied prices from the stock market rise, as well as rising prices of software and related products—this category has 30 times the weight in core PCE compared to core CPI.

As for PPI data, the situation is more complex. The energy shock triggered by the Iran war continues to transmit along the supply chain, with the core PPI year-on-year growth rate expected to accelerate from 4.9% to 5.2%.

Waller's First Congress Appearance: Reduced Forward Guidance Intensifies Policy Uncertainty

Waller will appear before the House and Senate hearings on Tuesday and Wednesday, which will be his first public testimony on monetary policy since taking office as Federal Reserve Chairman in May.

Unlike the Powell era, Waller has previously indicated that he would reduce the forward guidance on interest rate prospects, making it difficult for the market to anchor its policy expectations. Columbia Threadneedle portfolio manager Ed Al-Hussainy bluntly stated, "The likelihood of a rate hike in July is higher than that of no hike," while noting that to reduce the inflation rate to 2%, "we will need some luck."

Lyngen stated that even if the CPI data is softer, the market may still maintain a certain degree of pricing for a July rate hike, and the possibility of the Federal Reserve unexpectedly raising rates when the market is not fully expecting it cannot be ruled out.

Bloomberg's chief U.S. economist Andrew Sacher holds a relatively moderate view. He believes that to significantly raise the likelihood of a rate hike, there need to be both "a CPI that is hotter than expected" and "Waller's obviously hawkish statements," with the probability of both occurring simultaneously being low—the current market-implied probability of a 24% rate hike already reflects a mainstream expectation of reservations regarding recent rate hikes.

Big Banks' Earnings Reports Open: High Earnings Growth vs. Policy Uncertainty

This earnings season kicks off with an unprecedentedly dense lineup. JPMorgan Chase, Bank of America, Wells Fargo, Goldman Sachs, and Citigroup will report their earnings before the market opens on Tuesday, followed by ASML and Taiwan Semiconductor's earnings later this week that will directly test the health of global AI chip demand.

According to Goldman Sachs' trading desk estimates, the market consensus expects second-quarter S&P 500 earnings to grow by about 22% year-on-year, the highest level since 2021, and it has exceeded consensus expectations in the past 11 quarters—of which the actual growth rate for the first quarter reached as high as 27%, exceeding expectations by about 15 percentage points, with the surplus mainly coming from AI-related sectors.

In the banking sector, one focus for JPMorgan Chase is the potential impact of Marianne Lake's departure on management premiums; Bank of America's visibility regarding expense spending and NII guidance is seen as a core variable affecting the stock price on that day; Citigroup benefits from the positive impact of ECB rate hikes on Services NII, and capital market expectations are relatively low, indicating a large potential upward space; Goldman Sachs is widely regarded as a core beneficiary of the AI capital market cycle, with its stock trading department attracting much attention; whether Wells Fargo can achieve its 2026 NII target still faces risks of insufficient deposit growth in the second half.

Goldman's market analysis warns that this earnings season may lack the additional catalytic effect brought by significant upward revisions in AI capital expenditure expectations seen in the previous quarter, and the market's reliance on earnings to continue driving index increases is encountering greater challenges in the context of a tightening macro policy environment.

Waller Sets Rate Hike Trigger Line, Policy Scale Clearly Tips

Waller’s speech on Monday at the New York Association of Business Economists was interpreted by the market as the clearest warning of a rate hike to date.

He stated that the core personal consumption expenditure (PCE) index has shown a year-on-year increase of 3.4% as of May, and has been rising continuously since January, having already shown an upward trend prior to the outbreak of the U.S.-Iran conflict. Factors driving inflation include tariffs, energy prices, and large-scale construction of AI infrastructure. "No matter how it's measured, inflation has been rising this year," he said, "I am currently concerned about the rising trend of core inflation."

Waller also cited the policy mistakes that led to uncontrolled inflation from 2021 to 2022 as a warning, stating that the FOMC was widely criticized at that time for delaying rate hikes, a mistake that cannot be repeated. He made it clear that if he sees several months of cooling data, he would support remaining on hold, but the conditions for this are quite strict.

These statements align with the direction of last month’s FOMC meeting minutes—minutes show that half of the 18 officials expect at some point this year to raise rates at least by 25 basis points, and the options for rate hikes are shifting from marginal topics to the center of policy discussions. According to analysis from Goldman economist Jan Hatzius's team, Waller's latest statements, together with the June meeting minutes, confirm that the committee's openness to restarting rate hikes is significantly increasing.

The Triple Pressure of Rate Hike Risks: Growth, Capital Costs, and Historical Precedents

Goldman Sachs explicitly states in its latest weekly stock market strategy report that if the Federal Reserve restarts rate hikes, U.S. stocks will face triple pressure in the short term.

First, tightening policies will directly suppress growth expectations. Although the importance of economic growth to the stock market is higher than the interest rate level, all else being equal, a tightening monetary policy will weigh down the market's judgment on growth prospects.

Second, the capital intensity of this economic cycle has significantly increased. AI infrastructure-related stocks currently account for 42% of the total market capitalization of the S&P 500, expected to contribute about 50% of total earnings growth in 2026. Goldman data shows that the capital expenditure of large-scale cloud computing companies this year is expected to be equal to 100% of their operating cash flow, with net debt reaching $239 billion in the first quarter of 2026, a year-on-year increase of about 190%. Meanwhile, total equity financing in the U.S. for the second quarter reached $252 billion, setting a historical record, surpassing the previous high in the first quarter of 2021. Any rise in capital costs will directly impact the crucial growth engines of this cycle.

Third, historical data indicates that Federal Reserve interest rate hikes are an important precursor to peaks in overvalued, highly concentrated bull markets. Rate hike cycles in 1929, 1972, 1987, and 1999 all occurred before peaks in bull markets, while in 2022, the market peaked in advance along with interest rate expectations. Goldman’s rate strategists estimate that if interest rate volatility rises to levels seen during the rate hikes from 2022 to 2023, the corresponding S&P 500 price-to-earnings ratio would shrink by about 6%, equivalent to about a 1-time valuation contraction.

Goldman currently gives the S&P 500 year-end target of 8600 points and a 12-month target of 8300 points, representing around 14% and 10% potential upside from the current 7544 points, respectively. However, strategists emphasize that the realization of these targets is conditional on the macro policy environment not experiencing substantial tightening—this condition will be directly tested within the next two days.

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