Don't Blink – Rate Hikes Are Back

They did it, they actually did it. After months of talking tough on inflation, Chairman Kevin Warsh and the rest of the Federal Open Market Committee unanimously voted to raise the Federal Reserve's benchmark interest rate to a target range of 3.75%–4.00%. It was a moment at once widely anticipated yet shocking to think about. Inflation has been above the central bank's 2% target for a while now — five and a half years to be exact — yet coming into the year market watchers were talking about multiple rate cuts.

Why did the central bankers pull the trigger? Pretty simply, a resilient labor market. The August employment report showed a steady 4.1% unemployment rate and 162,000 jobs added, far more than the expected 55,000, alongside the prior two months of job gains being revised higher as well. Given that strength, Warsh and other policymakers felt there was sufficient room to prioritize fighting inflation without too much risk of a recession in the near-term.

The Fed's quarterly Summary of Economic Projections reinforced this point, as it indicated a mix of stronger growth, higher inflation, and lower unemployment. Naturally, this meant officials' interest rate expectations were also revised higher as well, with most expecting at least one more hike this year.

Though the central bank says it's committed to fighting inflation, it's easy to say that when unemployment is still stable and growth is strong. It's harder to do that if growth slows and layoffs rise. The market isn't really focusing on this possibility for now, but the focus will probably shift to that question the longer the Fed bares its hawkish talons.

Stagflationary Winds From Overseas

While the Fed is raising interest rates to fight inflation at home, international developments are making it an uphill battle. As has been par for the course this year, disruption to the oil & gas trade in the Strait of Hormuz is still the main concern for markets, and hostilities expanded dangerously in September when the Saudi Arabian East-West pipeline was struck and flows were temporarily disrupted. This pipeline had been a critical bypass route, moving around 4-5 million barrels per day of oil that had been transported through the Strait of Hormuz pre-war, or 20-25% of the chokepoint's total pre-war oil trade.

In response, Brent crude oil prices (the international oil benchmark) rose 13.7% to $103/bbl. But the impact was perhaps most acutely felt in the refined products space. The national average for diesel prices rose from $5.63/gal to $6.39/gal in September, setting an all-time record high in the process. The diesel surge has become such an economic drag — up 80% this year and posing a major headwind ahead of midterms and the holiday season — that President Trump is now considering a U.S. diesel export ban to trap supply domestically, despite the many pitfalls associated with such a move.

Though Treasury yields have been trending higher since February, they really took off this past month: The 2-year yield rose from 4.35% to 4.89%, while the 10-year rose from 4.77% to 5.29%. The latter move is especially important because 30-year fixed mortgage rates follow its direction very closely. For the median priced home and a 20% down payment, that translates to more than a $100 increase in monthly mortgage payments. These developments have made stagflation a real threat to the broader economy.

Market Recap

Macro

•   The Federal Reserve raised its benchmark interest rate by 25bps to a target range of 3.75%-4.00%.

•   162,000 jobs were added in August, significantly above consensus for gains of 55,000. Meanwhile, the unemployment rate remained stable at 4.1%.

•   Core PCE inflation came in at 3.0% y/y in August, lower than expectations for 3.3%. Methodological changes played a large role, with annual revisions to national economic data responsible for a 0.3 percentage point drag.

•   Diesel prices surged from $5.63/gal at the start of the month to as high as $6.53/gal on Sept. 21, before ending the month at $6.39/gal, a monthly increase of 13.4%.

•   The Japanese Yen appreciated from 160 to 157 against the U.S. Dollar, boosted in part by supportive comments from Treasury Secretary Scott Bessent and FX interventions from Japan's Ministry of Finance.

Equities

•   Large-cap Growth stocks were the only size & style combination to record a positive September at +2.2%. Large Value, Small Value, and Small Growth all recorded losses at -3.1%, -5.2%, and -5.3%, respectively.

•   Powered by the Magnificent Seven stocks and AI theme, Information Technology and Communications were the only sectors with positive returns at 4.5% and 4.3%, respectively.

Fixed Income

•   Government and corporate bonds all saw losses of greater than 2% in September, the first such event since September 2022.

•   Driven by a combination of resilient economic growth, fiscal deficit concerns, and the ongoing global energy shock, Treasury yields rose 40-50 basis points across the curve, with yields broadly at their highest levels since the 2000s.

•   While Investment Grade credit spreads ended the month only 2 basis points above where they began, High Yield spreads widened 50 basis points to 3.11%. The most since March 2026.

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