Federal Reserve rate hike: One and done?

Key takeaways

• The Federal Reserve raised rates, with one more hike expected before a prolonged pause
• U.S. inflation pressures look different from 2021 and 2022, supporting a gradual disinflation outlook
• Resilient earnings and neutral investor sentiment continue to support the equity market backdrop

The Federal Reserve dominated markets this week, raising interest rates in a move that had been widely anticipated. The bigger question for investors was what comes next.

For our Director and Senior Portfolio Manager Alex Cousley, the latest move looks more like a limited adjustment in rates than the beginning of a sustained hiking cycle.

The Fed’s latest projections point to one further rate increase in December, followed by a pause. That is broadly consistent with our view that policymakers may raise rates once more before allowing time for inflation pressures to ease.

While inflation has picked up recently, Cousley explains that the backdrop looks quite different from 2021 and 2022. Energy prices linked to the Middle East conflict have contributed to the latest increase, but two of the major drivers of the previous inflation cycle remain relatively subdued.

The first is wages. The U.S. labor market has remained resilient and is showing some signs of improvement, but wage pressures have not accelerated meaningfully. The second is housing, where activity remains relatively soft.

Together, these factors support our expectation for a gradual disinflation trend over the next 12 months rather than a sustained reacceleration in price pressures.

From an investment perspective, U.S. government bonds now look more attractive following the repricing in interest rates. However, sentiment has not become sufficiently dislocated to suggest a strong tactical buying opportunity just yet.

The Bank of England (BoE) also met this week, leaving rates unchanged.

The UK economy remains under pressure, while elevated energy prices continue to create some inflation risk. Given that combination, we expect the BoE to remain on hold for an extended period rather than embark on another meaningful tightening cycle.

China presents a different challenge.

Recent credit data showed continued weakness in borrowing demand from both households and businesses. A soft property market continues to weigh on mortgage demand, while weaker consumer confidence and subdued economic activity are limiting companies’ appetite for capital expenditure and expansion.

Local government financing has provided some support, but not enough to materially change the broader picture.

Cousley expects Chinese growth to remain relatively subdued, at around 4% to 4.5%, but not weak enough to trigger aggressive stimulus from policymakers. That leaves China in a softer growth environment where selective policy support is more likely than a major intervention.

Global equity markets were relatively unchanged through Thursday’s close after weakness earlier in the week was followed by a rebound.

Looking beneath those moves, Cousley continues to see a broadly constructive setup through Russell Investments’ cycle, valuation and sentiment framework.

The economic cycle remains supportive, with activity proving resilient and corporate earnings looking even stronger. Profit margins have improved, while the ongoing wave of AI-related capital expenditure is supporting investment. Early signs are also emerging that AI adoption may be helping companies improve business operations and, in turn, profitability.

Valuations require more nuance. U.S. equities remain more expensive than many international markets, but current levels do not appear extreme.

Sentiment is also close to neutral. Investors are neither displaying signs of euphoria nor the panic that might create a significant tactical buying opportunity.

Taken together, supportive economic fundamentals, robust earnings, reasonable valuations and balanced sentiment continue to provide a constructive backdrop for risk assets. In our view, that leaves room for investors to maintain a modest preference toward equities while remaining selective across markets.

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