Fed Rate Decision Looms as U.S. Stocks End Volatile Week Lower

U.S. stock markets are facing a critical test this week as investors await a highly anticipated interest rate decision from the Federal Reserve. The focus on monetary policy comes after a volatile week that saw major indexes post losses, despite a strong rebound in Friday's session.

Weekly Losses Despite Friday Rebound

All three major U.S. indexes snapped a four-day losing streak on Friday, with the Dow Jones Industrial Average gaining 0.98%, the S&P 500 rising 0.86%, and the Nasdaq Composite adding 0.96%. However, the late-week rally was not enough to offset earlier declines.

For the week, the major averages finished in negative territory:

• The Dow fell 1.6%, marking its longest losing streak since late April.
• The S&P 500 slid 0.8%.
• The Nasdaq dropped approximately 0.7%, its first down week in three.

Rate Hike Expectations Solidify

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Markets are now pricing in a high probability of a Fed rate hike on Wednesday, a move intended to combat persistent inflation. According to LSEG data, Fed funds futures on Friday implied a more than 80% probability that the central bank will lift its benchmark rate by a quarter-point, or 25 basis points, from the current 3.5%-3.75% range.

Expectations for a hike have been bolstered by several recent factors, including a hawkish speech from Fed Chair Kevin Warsh last month and a stronger-than-expected jobs report. The case for tightening was further strengthened by data on Friday showing that the core Consumer Price Index (CPI), which excludes food and energy, rose a hotter-than-forecast 0.3% in August.

Bond Yields Climb, Analysts Weigh In

The prospect of higher rates has pushed government bond yields upward, creating headwinds for equities. The yield on the benchmark 10-year Treasury note touched 4.99% on Friday, its highest level in nearly three years, before closing at 4.97%.

Analysts believe the market's ability to absorb higher rates will depend on the Fed's future path. Economists at JPMorgan said in a note that a "shallow hiking cycle" should be manageable for stocks, but a broader campaign of four to five hikes could lead to "more significant downside." Deutsche Bank stated it expects a total of 75 basis points of tightening, with hikes in September, December, and March to unwind last year's "risk management rate cuts."