Higher Rates, Lower Uncertainty

Doug Walters, CFA

Higher interest rates are rarely welcomed. Yet markets are often more concerned about uncertainty than unpleasant news. This week, we explore why the Fed’s decision may have reassured investors and what it reveals about the long-term nature of market behavior.

A business professional confidently ascends a sharply angled arrow representing increasing interest rates, illustrating how markets and investors adapt to changing economic conditions and long-term opportunities.

Contributed by Doug Walters, David Lemire, Max Berkovich, Matthew Johnson

Markets do not usually celebrate higher interest rates. Higher rates can make mortgages, automobiles, and other debt-financed purchases more expensive. They can also increase financing costs for businesses and put particular pressure on companies that rely heavily on floating rate debt. All else equal, none of that is especially good for investors.

Yet last week’s interest-rate increase offered a useful reminder that markets rarely respond to one fact in isolation.

The Federal Reserve raised its target interest rate range by one-quarter of a percentage point, to 3.75% to 4.00%. It was the first increase in more than three years and was approved unanimously by the Federal Open Market Committee (FOMC). The decision was widely anticipated, although public calls from the President for lower rates added a political dimension to the meeting.

The Fed’s Concern

One of the Fed’s mandates is price stability. It’s a bit of a misnomer. They do not want static prices… they want prices to grow at a modest rate of around 2%. That is the rate they believe supports long-term economic stability. Currently, core inflation (ex-food and energy)¹ is running around 3.3%, up from its 2.4% low in March 2025. So, it is high and moving in the wrong direction. Raising rates can have the effect of slowing down the economy, putting downward pressure on demand for products, and helping reduce inflation.

The unanimous decision highlights the clear choice that faced the Fed. One possible interpretation of the market reaction is that some investors were reassured by the Fed’s willingness to respond to persistent inflation despite political pressure for lower rates.

That does not mean higher rates suddenly became good for markets. It means the alternative may have looked worse. If investors concluded that the Fed was unwilling or unable to respond to persistent inflation, longer-term inflation expectations could rise. Lenders might require greater compensation for holding bonds. Businesses and households could become less confident about future purchasing power. The resulting uncertainty could weigh on valuations well beyond the effect of a single rate increase. The decision helped answer at least one question: the Fed was willing to act.

Further Down the Road

This episode highlights the long-term nature of market behavior. Investors do not react only to whether an event is “good” or “bad” today. They react to how an event compares with expectations and how it changes the range of future outcomes well down the road. A rate increase imposes a visible near-term cost. Yet it can also help reduce a less visible long-term risk.

The market response was not uniformly positive. Equities pulled back following the press conference as investors considered the possibility that inflation and rates could remain higher for longer. Yet by Friday’s close, the S&P 500 was approximately 0.9% above its September 15 close. By the end of day Monday, those gains extended to 2.4%.

For long-term investors, the practical response remains familiar. We do not need to predict each Fed decision or correctly interpret every market move. Portfolios should be prepared for several possibilities, including persistent inflation, additional increases, an eventual pause, or economic weakness. Diversification across investments and maturities, thoughtful rebalancing, and attention to balance-sheet strength can help reduce dependence on any one policy outcome.

Sometimes the immediate medicine is unpleasant. What may matter more is whether investors believe the problem is being treated.

1. U.S. Bureau of Economic Analysis, Personal Consumption Expenditures Price Index Excluding Food and Energy, year-over-year change through July 2026.

What is right is not always popular and what is popular is not always right.
Original author unknown

One thing to watch

This week, all eyes were on the Fed decision as discussed above. In the coming week, we plan to keep our eye on long-term Treasury yields. The Fed directly influences short-term interest rates, but long-term Treasury yields reflect investor expectations for inflation, growth, and government borrowing. If yields remain stable following the rate increase, it may suggest investors believe inflation risks are becoming more manageable. Continued upward pressure could signal lingering concerns.

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