September has earned its reputation as one of the more difficult months for markets, and this year is doing its part to live up to it. Between a Fed meeting that’s carrying more weight than it has in a while and a geopolitical backdrop that hasn’t let up, there’s a lot to sort through this month.
The Fed begins its two-day meeting today, which will culminate in an interest rate decision. At the beginning of the year, most investors would have likely bet on greater chances of a rate decrease over a rate increase. Now, however, the narrative has changed. In fact, the FedWatch tool from the CME Group has the likelihood of a rate increase up to a 92% chance.
The war in Iran has extended far past initial timeline estimates, keeping oil prices higher for longer and impacting energy costs. Inflation has stayed hotter than expected, and the jobs market has been strong. These points, paired with a more hawkish Fed Chair in Kevin Warsh, have ultimately flipped the narrative from rate cuts to rate hikes.
Energy costs continue to be the primary culprit for higher inflation today compared to one year ago. These higher costs have led to the hot inflation, which in turn pushes the Fed towards a more conservative stance on interest rates. All these points are working in tandem.
Treasury yields have been the clearest market reaction to this shift. The 10-year yield has climbed to a high of 5.04%, a level we haven’t seen since 2007, and the move has been fairly swift given how quickly the rate-hike probability has built over the past several weeks. As yields rise, bond prices move the opposite direction, which has weighed on bond returns this year despite a still-respectable coupon. I wrote in the August Viewpoints about how price movement, not coupon income, has been driving the bulk of bond returns in this environment, and September has been another example of that same dynamic at work.
None of this changes how we’re thinking about client portfolios. This kind of shift is exactly why we build fixed income allocations around duration and rate sensitivity – we want bonds to behave like bonds. Lower risk and lower volatility. It’s also a reminder that a hawkish turn from the Fed doesn’t automatically mean trouble for equities, which have shown resilience through plenty of rate uncertainty before. Where the Fed ultimately lands this week, and what it signals for the months after, remain to be seen. As we so often say, today’s headlines and tomorrow’s reality are seldom the same.
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