The case for a Fed pause strengthens

Key takeaways

• Softer inflation data and Fed commentary reduce expectations for an October rate hike
• Higher government bond yields are creating more attractive starting valuations
• Equity markets remain resilient, but higher rates are reshaping market leadership

Softer U.S. inflation and labor data as well as more cautious comments from Federal Reserve officials shifted the rates outlook this week.

Nonfarm payrolls came in below expectations at +29k in September and core PCE inflation came in below expectations at 3% year over year in August. Our Global Chief Investment Strategist Paul Eitelman sees the data as another reason for the Fed to take its time before tightening policy further.

That view was reinforced by comments from Fed Vice Chair Philip Jefferson, who suggested policymakers may need more time before making further adjustments, while Governor Michelle Bowman said she did not see an urgent need for additional action.

Markets responded quickly. By Thursday, the implied probability of an October rate hike had fallen to roughly 20%. 

The potential for a Fed rate hike pause comes after an unusually difficult quarter for global fixed income.

The U.S. 10-year Treasury yield reached its highest level since 2002 before edging lower on Thursday. Resilient economic growth, sticky inflation, the prolonged Middle East conflict and intense competition for capital all contributed to the rise in yields during the third quarter.

AI infrastructure spending has become part of that story. Companies are raising significant amounts of capital to fund the buildout at the same time governments are financing large budget deficits, increasing the amount of debt investors are being asked to absorb.

For Eitelman, the repricing has also created opportunity. Higher starting yields have improved valuations across government bonds, making the asset class more attractive than it was earlier in the year. 

The pressure has not been confined to U.S. markets, with French government bonds also coming under strain during the quarter as concerns around public finances and political uncertainty ahead of the 2027 election pushed yields higher.

Global equities have held up surprisingly well despite the volatility in bond markets.

The S&P 500 and MSCI All Country World Index remain roughly 2% below their all-time highs, suggesting that the broader equity backdrop remains resilient.

Underneath the headline indexes, however, higher rates are having a more visible impact.

Rate-sensitive areas of the market have struggled, particularly small caps. The Russell 2000 Index has fallen roughly 9% since mid-August, coinciding with the sharp move higher in bond yields.

As Eitelman notes, this is another reminder to look beyond headline index performance. Equity markets may appear broadly stable but changing interest-rate conditions are creating meaningful differences across sectors, styles and company sizes.