Investing.com -- A sustained rise in interest rates could weigh on equity prices and revive concerns about U.S. fiscal sustainability, a Goldman Sachs economist argues, adding to a drag on economic growth that he currently sees as manageable.

Rates have risen sharply this year, and the latest jump in long-term yields has "tightened financial conditions noticeably,” economist Pierfrancesco Mei wrote.

Goldman’s baseline assumes one more Fed hike in December, followed by three cuts starting in the second half of 2027, with the 10-year Treasury yield easing from 5.3% to 4.4% by the end of 2027.

Under that scenario, the bank estimates higher rates will subtract about 0.2 percentage points from 2027 GDP growth, leaving the economy expanding close to its 2.3% potential. If current rates persist, the drag would rise to slightly over 0.5 percentage point.

Housing is the most exposed sector. With mortgage rates up more than 1 percentage point since February, over 90% of borrowers hold mortgages priced below market rates, giving them little incentive to move.

Mei expects higher rates to subtract about 2 percentage points from annualized residential investment growth in the fourth quarter and 1 point on average in 2027, with the drag roughly twice as large if rates stay at current levels.

Consumer spending growth should slow by about 0.2 percentage point in 2027, Mei noted, as higher rates curb credit-financed purchases of durable goods such as vehicles, partly offset by higher net interest income.

Business investment faces a 0.3-point drag as companies refinance debt at higher rates, with small businesses more exposed because about half their debt is variable-rate, the economist continued.

Until recently, Mei said, the drag from higher rates was roughly offset by higher equity prices, tighter credit spreads and a weaker dollar. Financial conditions are now tightening.

The first additional risk is to equities. Goldman’s strategists expect stocks to rise slightly over 10% by the end of 2027, but stable rates could limit that upside. “If equities were roughly flat through 2027 because of higher rates, the missing boost from wealth effects would lower consumer spending growth by just under 0.5pp,” Mei said.

The second is fiscal. Higher rates "have revived fiscal sustainability concerns," Mei wrote. The large primary deficit remains the main driver of rising debt, but persistently higher rates would raise interest costs and push the debt-to-GDP ratio up faster, increasing the odds that deficit reduction becomes necessary sooner, he added.

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