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Recalibrating Rates, Not Tightening Policy
The Fed’s latest 25 basis point hike might represent a recalibration rather than tightening. Instead of focusing on the next hike, investors should watch broader financial conditions and the long-term trajectory for interest rates.
- Portfolio Construction
- Markets & Economy
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- Monetary Policy
Key Points
The Fed’s latest 25 basis point hike might be a technical adjustment rather than a policy shift.
Broader financial conditions matter more than policy rates in isolation.
Investors should be more concerned with the long-term trajectory for rates than the next hike.
Markets love simple narratives. A rate cut is dovish. A rate hike is hawkish. A pause falls somewhere in between. The Federal Reserve's latest 25 basis point increase has therefore been interpreted through a familiar lens: tighter policy, more pressure on growth, and another obstacle for risk assets.
That interpretation may be too simplistic.
Not every move in the federal funds rate signals a change in policy direction. Sometimes a central bank adjusts nominal rates simply to maintain the same degree of restraint. The key distinction is between nominal and real rates. Monetary policy is ultimately transmitted through the latter. If inflation expectations rise while policy rates stand still, the real stance becomes easier. A modest increase in nominal rates may therefore represent recalibration rather than tightening.
Recent market pricing provides important context. Long-term inflation expectations, as captured by 5-year, 5-year forward inflation rates, have remained broadly stable for months, suggesting that current inflation pressures have not become embedded in longer-term expectations. A limited and well-signaled increase may therefore prove to be a recalibration rather than the start of a sustained tightening cycle.
The complication is that policy rates no longer tell the whole story.
Broader financial conditions matter more than policy rates in isolation. Credit spreads, equity valuations, the dollar and long-term bond yields are what determine financing conditions for households and businesses. A widely anticipated 25 basis point increase that has already been discounted by investors may have little incremental effect. By contrast, the rise in longer-dated Treasury yields over the past year has exerted meaningful tightening pressure without any additional action from the Fed.
There is also the uncomfortable reality that inflation is not solely a demand story. Sticky services inflation continues to reflect structural supply constraints, while energy-price shocks remain capable of lifting headline inflation regardless of policy settings. History suggests monetary policy has only limited influence over either.
This is why investors should focus less on the next 25 basis points and more on the trajectory beyond it. As the old market adage goes, historically it has often been the last rate hike, rather than the first, that causes trouble. A cumulative 75 basis point recalibration spread over six months is manageable and largely priced in. The genuine risk would be something more aggressive: a sustained tightening cycle exceeding 125 basis points over the course of a year. That would signal a meaningful shift in policy intent rather than a technical adjustment.
For now, the Fed may simply be recalibrating the dial, not turning the screws. The distinction is subtle. For markets, it is everything.
— Peter Wilke, CFA – Head of Tactical Asset Allocation, Global Asset Allocation
Interest Rates
Market expectations shifted decisively ahead of the September Federal Open Market Committee (FOMC) meeting following Chairman Warsh’s Jackson Hole remarks and stronger-than-expected employment and inflation data. The Committee validated that repricing with a unanimous 25-basis-point rate increase. The policy statement highlighted resilient domestic spending and a timelier return to the Fed’s 2% inflation goal.
During the press conference, Warsh repeatedly emphasized inflation risks and the importance of restoring price stability. He noted that the Committee had “removed a dose of accommodation,” but declined to characterize policy as restrictive or provide explicit forward guidance. Markets interpreted his comments as hawkish, pushing front-end Treasury yields higher, flattening the curve and adding to expectations for further hikes.
We think markets may be overestimating the persistence of the tightening cycle, although one or two additional hikes over the next year appear reasonable if underlying inflation remains firm. With Treasury yields near our fair value estimates, we remain neutral on duration.
— Dan LaRocco, Head of Liquidity, Global Fixed Income
- Markets sharply increased the probability of a September rate hike ahead of the meeting.
- The FOMC validated that repricing, while Warsh’s inflation focus left the door open to further tightening.
- We see one or two additional hikes as reasonable and remain neutral on duration.
Credit Markets
Second-lien bonds are re-emerging in the U.S. high yield market, with more issuers carrying both first- and second-lien debt than in 2023. They now represent roughly 3% of the high yield index, versus just over 1% of the leveraged loan market.
This growth reflects a trade-off for borrowers in a higher-rate environment: pledging collateral can lower borrowing costs and support credit ratings, while second-lien debt enables companies with substantial existing obligations to raise capital when traditional options are constrained. That flexibility carries additional downside risk for investors. Second-lien bonds rank behind first-lien debt and therefore require greater compensation for weaker recovery prospects. The spread premium over first-lien bonds from the same issuer has widened from roughly 90 basis points at the start of 2025 to nearly 400 basis points today.
This repricing creates a real opportunity, but additional yield cannot be considered in isolation. Issuer fundamentals, collateral coverage and the broader capital structure will determine whether the premium adequately compensates for the risk, making security selection critical.
— Ben McCubbin and Sau Mui, Co-Heads of High Yield, Global Fixed Income
- Higher rates and financing flexibility are driving greater use of second-lien debt.
- The spread premium over comparable first-lien bonds has widened substantially.
- Second-lien bonds’ wider premium offers attractive opportunities, but security selection remains critical.
Equities
The gap between the capitalization-weighted and equal-weighted S&P 500 Index has widened to its largest level in 20 years, underscoring increasingly concentrated U.S. equity returns. While broad market indices have reached new highs, a growing share of gains has come from a relatively small group of the market's largest companies.
Narrow leadership is not unprecedented, with similar episodes around the Global Financial Crisis and pandemic-era rally. The current regime, however, has been more persistent. After participation briefly broadened early in the second quarter, leadership reconcentrated among large-cap growth companies, supported by strong earnings and enthusiasm around AI-related investment. Headline performance may therefore overstate the breadth of the market advance, but concentration does not imply weak fundamentals. Cap-weighted benchmarks remain efficient vehicles for market exposure, although returns increasingly depend on a concentrated group of companies. Distinguishing broad exposure from concentrated leadership remains important when assessing portfolio diversification and sources of risk and return.
— Jordan Dekhayser, Senior Equity Client Portfolio Management and Daniel Kim, Associate Equity Client Portfolio Manager
- The return gap between the cap-weighted and equal-weighted S&P 500 Index has widened sharply.
- Most of the divergence has emerged since 2023 as market leadership has reconcentrated.
- Concentration exceeds post-GFC and pandemic-era peaks, with returns heavily influenced by a handful of stocks.
Real Assets
Gold advanced during August as softer U.S. labor market and inflation data reduced expectations for additional Federal Reserve tightening. While the data strengthened in September and subsequently reduced part of that policy re-pricing, the August moves demonstrated how a decline in Treasury yields and real interest rate expectations can increase gold’s appeal relative to income-producing assets. A weaker U.S. dollar provided further support by improving affordability for international buyers and strengthening global demand. Together, these shifts helped gold rebound after a period of consolidation earlier in the summer.
Safe-haven demand added to the favorable backdrop. Ongoing geopolitical uncertainty and concerns about global growth encouraged investors to seek defensive assets, while central banks remained significant buyers of gold reserves. The combination of lower real rate expectations, dollar weakness, continued official-sector demand and renewed risk aversion supported gold throughout August. Tactically, we remain neutral global natural resource equities, preferring not to chase outperformance from commodities after the recent rally.
— Jim Hardman, Head of Real Assets, Multi-Manager
- Softer U.S. data reduced tightening expectations and lowered Treasury yields during August.
- Geopolitical and economic uncertainty supported safe-haven demand for gold, alongside dollar weakness and central bank buying.
- Gold’s strength does not alter our view; we affirm our neutral weight to global natural-resource equities.
Unless noted otherwise, data is sourced from Bloomberg as of September 2026.
Main Point
A hike doesn’t represent a policy shift
For now, the Fed may simply be recalibrating the dial, not turning the screws. The distinction is subtle. For markets, it is everything.
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