Investors are finding reasons for optimism as the Federal Reserve's commitment to tackling inflation becomes clearer, yet lingering worries about energy costs and artificial intelligence investments are preventing them from going all-in.

Last week, the Fed managed to reaffirm its credibility by delivering a hawkish stance that nonetheless avoided hinting at an aggressive cycle of rate increases, showing it remains proactive rather than reactive. Although this initially calmed markets, anxiety resurfaced on Friday as the 10-year Treasury yield once again approached the 5% threshold and the S&P 500 swung between gains and losses. Even with some retreat in oil prices, Brent crude continues to trade above the $100 per barrel mark.

"Until inflation pressures tied to energy ease, it's challenging to see rates and equities achieve full stabilization," said strategists at Barclays Plc, led by Emmanuel Cau. "Still, the encouraging aspect is that the Fed's independence and credibility have been restated, offering clarity on its policy response mechanism."

The Fed's decision can be viewed as a pivotal moment that clears the air. The cautious mood among investors leading up to the policy meeting indicated they were far from overconfident, with noticeable moves to trim positions while adding protective hedges. The sizable quarterly options expiration on Friday also helped significantly in recalibrating market positioning.

"Given solid earnings growth, contained credit spreads, and a calm VIX, the fundamental backdrop for US equities remains favorable, keeping us optimistic on the S&P 500 despite short-term fluctuations," noted Manish Kabra, strategist at Societe Generale SA. He views the yield curve as a vital indicator, and as long as it avoids inversion, he anticipates the benchmark reaching 8,000 by the end of the year, notwithstanding some turbulence.

While the possibility of a year-end rally is still alive, the path there may be rocky. Rising diesel prices point to higher inflation ahead, and unless the situation in Iran is resolved quickly enough to meaningfully lower oil costs, the central bank may be forced to adopt an even stricter policy stance.

According to the swap market, traders are pricing in three additional rate hikes by the end of July. Focus is on the potential for a bond market shock, with 10-year yields exceeding 5% making Treasuries more appealing. However, as long as economic growth and earnings stay resilient, investors might be hesitant to abandon equities and instead opt to diversify their holdings further.

Strategists at Bank of America Corp., spearheaded by Jared Woodard, have turned more cautious, arguing that current positioning remains overly bullish given the anticipated slowdown in earnings next year. They point out that the projected 10%-15% growth for 2027 would require an ISM manufacturing index staying above 53 for an extended period. "It's not yet the moment for defensive stocks, but focusing on quality, value, and yield seems wise," they advised.

Skepticism is mounting regarding AI spending and the potential returns on those investments, casting doubt on the earnings outlook for the entire ecosystem of AI beneficiaries. Meanwhile, a shift is occurring within the technology sector, with software names regaining strength while semiconductor stocks have mostly plateaued over the past two months and shown increasing volatility.

Valuations in the S&P 500 have decreased notably, with the benchmark now trading just above its long-term average. Although this de-rating is largely due to surging earnings projections, the recent pullback suggests investors are unwilling to pay a premium for growth, whether at the index level or within specific sectors.

If caution persists in the near term, a robust earnings season in the coming weeks could spark a revival in sentiment and encourage more risk-taking.

"The market's resilience indicates that investors are differentiating between higher rates resulting from persistent inflation and a fundamentally worsening economic outlook," said Daniela Hathorn, senior market analyst at Capital.com. "For the time being, the latter hasn't become the primary worry."