Fed hikes and keeps options open; 7 key takeaways

Federal Reserve (Fed) policymakers hiked rates to a range of 3.75% – 4.00%, which was the first rate increase in three years. More importantly, the so-called dots projected more rate hikes are possible this year, reflecting a committee that sees higher growth and higher inflation this year.

During the post-meeting press conference, Chairman Kevin Warsh remained steadfast on the inflation vigilance, backing the rather hawkish tone implied by the dots.

U.S. stocks and bonds saw declines post announcement. The 2- and 10-year U.S. Treasury yields moved higher to around 4.74% and 5.02%, respectively. The S&P 500 fell nearly 1% from its highs on the day.

1. The Fed is likely to hike again, but a sustained series is not assured

The Fed has historically moved in a series rather than stopping after one hike. However, today’s inflation is being driven partly by the crude oil supply shock, and a decline in oil prices could quickly ease inflation, as seen in June and July. The Fed may hike once more and then reassess conditions.

2. Warsh is keeping his cards close to the vest

Chairman Warsh’s messaging is more controlled, both in the length and substance of his answers. He has repeatedly resisted providing forward guidance, taking a “less is more” approach and allowing markets to interpret the data. Of course, rate decisions aren’t decided by one person.

3. The hike shouldn’t materially alter near-term economic growth

Market rates were already elevated, with the 10-year U.S. Treasury yield above 4% for the past two years and 30-year mortgage rates above 6% since mid-2022. Still, higher rates are likely to cool growth on the margin.

4. The first hike hasn’t typically ended the bull market

Stock market returns have historically skewed weaker in the months following the first rate hike but improved over the subsequent year. The first hike has also not typically marked the end of the bull market.

5. We’d view a deeper pullback in stocks as an opportunity

The bull market continues to deserve the benefit of the doubt. Superior earnings trends and reset valuations should also favor technology and other growth areas on a relative basis.

6. A 5% 10-year Treasury yield improves the risk-reward for fixed income

The 10-year U.S. Treasury yield’s move toward 5% has created a more attractive entry point for fixed income investors. Higher yields improve forward-looking return potential, provide greater compensation for interest-rate risk, and support a constructive outlook for duration.

7. The Fed reinforced its independence

Today’s rate hike and projection of additional hikes should help dispel concerns about the Fed’s independence. As Chairman Warsh put it, the Fed is “staying in our lane” and setting policy based on economic conditions.

At its September rate-setting meeting, the Federal Open Market Committee (FOMC) increased the target range for the federal funds rate to 3.75% – 4.00%. Notably, the decision to raise the target rate was unanimous. There were no other policy changes.

The FOMC also released its quarterly Summary of Economic Projections (SEP), which now sees modestly more economic growth this year and next, and higher inflation. Additionally, a majority of the committee – 16 of the 18 members that submitted rate projection dots – penciled in another rate hike by the end of 2026, while the median projection for 2027 does not currently anticipate any further policy tightening. Chairman Warsh continued to forego submitting dots given his stated strong opposition to using forward guidance.

During the post-meeting press conference, Warsh noted that the committee believes that the standard has not been satisfied that inflation trends are moving in the right direction. He stated that the committee is keenly focused on the price stability side of the dual mandate. In previous meetings, Warsh stressed that both price stability and full employment are important, with one not outweighing the other.

The Fed’s decision to raise rates by 0.25% largely aligns with market expectations and reinforces our view that inflation concerns are the primary issue driving policy decisions. While inflation uncertainty remains a key driver of rates, the recent rise in longer-dated U.S. Treasury yields also reflects growing concerns surrounding fiscal deficits, elevated debt issuance, ongoing geopolitical uncertainty, and resilient economic growth. A durable Middle East resolution would likely ease inflation pressures and allow yields to move lower, particularly at the front end of the curve. With the 10-year Treasury yield having recently found support near 5%, we continue to view the current rate levels as an attractive entry point for duration given the strong relationship between starting yields and forward-looking fixed income returns.

Since the start of the modern Fed era in 1994, when the Fed began announcing policy decisions immediately after its meetings, there have been six completed rate-hiking cycles.

Each cycle had unique circumstances, making direct comparisons difficult, and the sample size is relatively small. Still, history provides a useful starting point:

• Near-term market performance following the first rate hike has tended to skew negative. The S&P 500 declined in five of the six cycles over both the next one and three months.
• However, performance improved as the time horizon expanded. Stocks were higher 12 months later in five of the six cycles, with an average gain of 9%.
• The clear negative outlier was 2022, when the Fed delivered one of the most aggressive tightening cycles in modern history, raising rates by 5.25 percentage points. That is not our expectation today.
• Importantly, outside of 2022, the first rate hike didn’t end the bull market. Bull markets continued for another nine to 74 months.

This study ties into our broader view. The weight of the evidence suggests the bull market continues to deserve the benefit of the doubt, though the near-term path is likely to remain uneven as macro factors stay front and center. We are also in the historically choppier seasonal period associated with midterm election years.

The good news is that the S&P 500 and technology sector have already undergone a healthy reset. Since the June 2 peak, the S&P 500 is essentially flat, even as earnings estimates have continued to rise. As a result, valuations have contracted meaningfully.

The S&P 500’s forward price-to-earnings (P/E) has declined to 19x, near the oil-shock lows. Meanwhile, the technology sector’s P/E has fallen from 32x last October to 21x today, roughly where it stood when ChatGPT was launched in November 2022.

If we stress-test the market further, a return to the 2025 tariff-shock lows would imply roughly an 18x multiple for the S&P 500. Combined with key technical levels, this suggests the downside would be limited to the 5% to 8% range from here based on what we know today.

Ultimately, we would stay aligned with the primary market uptrend and view a deeper pullback as an opportunity. Moreover, even with short-term rates moving higher and posing a potential headwind to the broader economy, the recent reset in technology valuations leaves growth-oriented areas of the market better positioned.

The Fed delivered its first rate hike in three years and signaled that further tightening is possible, though the path remains uncertain given inflation’s sensitivity to energy prices. Markets are likely to remain choppy in the near term, but history suggests the first hike has not typically ended bull markets. We would view a deeper pullback in stocks as an opportunity, particularly in growth areas. Meanwhile, 10-year Treasury yields near 5% have improved the appeal of fixed income. Overall, the hike reinforces the Fed’s commitment to controlling inflation without materially altering the near-term growth outlook.