Strong growth and renewed inflation concerns have led investors to price a faster pace of Fed tightening.
- The 10-year US Treasury yield rose nearly 17 basis points last week to 5.16%, its highest level since 2007, while the 30-year yield reached its highest level since 2004.
- The probability of an October Fed hike increased from 53% to 64% over the week as stronger economic activity and higher energy prices raised market expectations for further tightening.
- The US flash composite purchasing managers’ index rose to 58.4 in September, its highest level since July 2021, while input costs increased at the fastest pace in nearly four years
But markets may be pricing a longer tightening cycle than the Fed ultimately delivers.
We expect one 25-basis-point increase in December, while markets are pricing several additional increases.
Higher energy costs may also constrain growth by reducing household purchasing power and increasing companies’ costs.
Our expectation is that underlying inflation pressures remain moderate, which would be consistent with a shallow Fed tightening cycle.
So, resilient earnings and higher starting yields continue to offer investment opportunities.
- We forecast S&P 500 earnings growth of 25% in 2026 and 14% in 2027, which should help equities absorb moderately higher yields while economic growth remains firm.
- We recommend positioning for further equity gains while diversifying across regions, sectors, and return drivers and managing concentrated single-stock exposure.
- We rate fixed income as Attractive and see opportunities to add portfolio income through medium- to long-duration high-quality bonds and medium-maturity credit from stronger investment grade issuers.
New this week
The S&P 500 gained 1.2% last week and finished within 1% of its record high, despite the rise in Treasury yields.
Did you know?
- US factory activity has remained in expansion territory for eight consecutive months. Historically, US manufacturing expansions have lasted nearly three years on average.
- US nominal GDP was growing 6.6% year over year at the end of the second quarter, comprising around 2.1% real growth and a 4.4% increase in the broad price level. This can help companies grow revenues and profits in current-dollar terms.
- Past US economic downturns generally did not begin until at least two years after the Fed started raising rates, although the timing varied with the scale of the tightening cycle.
Investment view
We expect one further 25-basis-point Fed increase in December and do not believe a measured tightening cycle will derail the US economy or equity rally. Investors should maintain diversified equity exposure and use the rise in yields to add selectively to quality bonds, while remaining cautious on the longest maturities and lower-quality credit.
