Emboldened equities ignore bonds’ warning – and the Fed

What happened

The Fed hiked for the first time in three years (to 3.75–4.00%) as inflation stayed sticky and oil rebounded, with Brent briefly topping US$130 a barrel. It wasn’t acting alone: the ECB, Bank of Japan and Reserve Bank of Australia also raised rates. But it was worries about growing government debt, especially in developed markets, that drove much of the rise in bond yields (the US 10-year hit pre-crisis highs). Bonds fell, and so did gold, which pays no income to offset higher yields. Amid the turmoil, equities held their ground on strong earnings: Q3 profit forecasts rose 1.4% during the quarter, in a quarter when they, more often than not, fell. But the rally’s risk was in its narrow base, powered mostly by the frantic AI trade.

What we’re watching

September’s was a “credibility hike”, not the start of a new cycle. What markets are worried about is the Fed’s willingness to bring down inflation, not that prices are already out of control. And although the Fed may raise rates further to achieve its objective, markets’ pricing of three to four hikes by mid-2027 looks too pessimistic, especially as the impact of energy and tariffs is temporary by nature. If the 10-year yield stabilises around 5.5%, that rich income can cushion further downside and set investors up for potentially double-digit returns when interest rates turn. That gives us conviction in staying invested in the short to middle part of the yield curve. Equities may take a near-term hit as higher interest rates discount more of future profits, but strong earnings can outweigh that – especially when supported by historic AI-driven earnings. In seven hiking cycles since the late 1980s, US stocks averaged a 9% gain in the year after the first hike.