Bond markets got what they anticipated last week, with the U.S. Federal Reserve and Bank of Japan following the European Central Bank in recently hiking rates, while the Bank of England held policy unchanged.
Read together, those decisions tell a different story than the one dominating headlines.
Over the past few months, anxiety around government debt and deficit levels has risen notably. But that’s not what the bond market is pricing. Curves are flattening in a textbook hiking-cycle pattern; front-end yields rising faster than the long end, with inflation breakevens broadly stable. That’s a classic signature of markets pricing a rate cycle, not a fiscal crisis.
The Fed decision reinforced the point. The committee raised the fed funds rate 25bps to 3.75 – 4.00% in a unanimous 12 – 0 vote, holding the balance sheet steady. The statement was unambiguous: “Inflation remains elevated. Today’s policy action will support a timelier return to the committee’s 2 percent goal.”
What moved markets, however, wasn’t the hike—it was priced in—but the hawkish undertone that followed. The dot plot shifted materially higher, with the median 2026 fed funds projection rising to 4.125% from June’s 3.75%, and 16 of 18 participants now expecting at least one more hike this year. Chairman Kevin Warsh reinforced this tone, noting he “would be hard-pressed to describe broad financial conditions as restrictive,” a view he said the committee widely shared. Treasury yields moved higher in response, led by the front end.
What Does This Cycle Look Like?
The hawkish tone at Jackson Hole last month anticipated exactly this dynamic: central banks need to see inflation return to target with sufficient speed before declaring victory. That hasn’t happened yet. Headline Consumer Price Index in the U.S. has printed in line with expectations, the jobs market remains resilient, and energy prices have staged a renewed run-up. The Fed’s own updated projections acknowledge this, with median headline and core Personal Consumption Expenditure inflation projected at 3.7% and 3.4% for the end of 2026, not receding to target until 2028.
The real debate, in our view, is whether this represents a genuine hiking cycle or a more limited, halting response to transitory pressures to ensure against second round effects given that the pressures are mainly supply side driven. Warsh’s press conference tilted the answer toward the former, citing higher inflation, solid growth and geopolitical factors pushing up energy prices. Importantly, resilient growth is doing much of the work here, allowing central banks the room to hike without derailing the expansion.
Our view has adjusted accordingly: we now expect one additional hike in December, followed by a pause, with the neutral rate settling around 4.00 – 4.25%. Subsequent progress on inflation should keep the committee on hold thereafter, though a tail risk of further hikes remains if energy prices stay elevated, a risk playing out differently across major economies.
Same Pressures, Different Responses
European and U.K. policy is tracking energy prices most directly; if crude keeps climbing, further tightening pressure is likely. The BoE’s decision captured that tension: the MPC held at 3.75%, but the 6 – 3 vote—with three members pushing for a hike—signaled hawkish intent, reinforced by guidance that inflation is now expected to push slightly above 4% early next year. The MPC is also slowing gilt sales, pausing them entirely until as late as April 2027 while it reviews how sales are implemented.
Japan shows similar hawkish substance paired with a measured market read. The BoJ delivered a 25-basis-point hike to 1.25%, the highest level in 31 years, though fully anticipated, and two dovish dissents left the yen weaker on the day. The central bank continues to flag broadening inflation risks, but markets are hearing “gradual” rather than urgent. How far the BoJ goes may hinge as much on next March’s Shunto wage talks as on near-term data.
The U.S. picture is more nuanced: Warsh’s reference to energy prices implied the committee is no longer looking through oil moves, tying policy more directly to headline inflation, including the trajectory of the U.S. – Iran conflict.
Implications for Portfolio Positioning
One consequence is that credit is less compelling today than a couple of months ago. As markets debate how restrictive policy needs to become, alongside early hints of a growth inflection, this is a sensible moment to revisit credit positioning.
This isn’t an argument that credit is broadly unattractive; rates are rising because inflation is higher and growth is holding up, both constructive for credit fundamentals. But elevated government debt levels mean credit may behave differently this cycle than the standard playbook suggests. One area we’ve already reduced is mortgage exposure, where a credit premium comes bundled with meaningful interest-rate volatility.
Taken together, these dynamics point to clear conclusions for portfolio construction. Policy rates, not deficits, have driven this repricing and will remain the key variable through year-end. With markets already pricing in more hikes than the Fed itself projected, we would be opportunistic in adding duration on any further backup; stabilization at these levels, not a return to prior lows, remains our base case. In practice, which means anchoring around short to intermediate rates for carry, while selectively adding longer-dated corporate exposure in structurally advantaged sectors, alongside high yield and intermediate-duration credit.
What to Watch For
Wednesday 09/23:
- U.S.: Manufacturing Purchasing Managers’ Index
- U.S.: Services Purchasing Managers’ Index
- Eurozone: Manufacturing Purchasing Managers’ Index
- Eurozone: Services Purchasing Managers’ Index
Thursday 09/24:
- U.S.: Initial Jobless Claims
- U.S.: New Home Sales
- Switzerland: SNB Interest Rate Decision
Friday 09/25:
- U.S.: Durable Goods Orders
