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After the Fed hike
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Why today’s bond backdrop looks different from 2022
Fed FOMO and FOMU
In the world of central banks, being the last one to act is rarely a good thing, especially when the macro shock appears to be shared across all major markets. After the Fed had ramped up its tough language against inflation, it was now time to act and join the tightening party that has been spearheaded by the ECB. From that perspective, the Fear of Missing Out (FOMO) has been addressed. So has the fear of falling behind the curve, at least for now. However, we may still face another Fed policy challenge: FOMU. The Fear of Messing Up, that is. For sure, the rate hike can be interpreted as credibility-enhancing, but we believe that there is still plenty of work to do before claiming that policy credibility has been fully restored. In particular, we are in the camp that would argue that the new Fed communication strategy is a major problem to the extent that it promotes greater rate volatility and policy uncertainty. To be fair, some market participants are less critical as they believe that Kevin Warsh’s tight-lipped approach could create a bit more discipline by market players, whereby more volatility today results in lower term premia tomorrow.
There is also another source of confusion on our radar. If the Fed only raises its policy rate one more time as suggested by the dots, can we call that a proper tightening cycle? Not hardly. And yet, the current and projected deviation from the official inflation target is such that there may be some policy inconsistency here. As an inflation-fighting central bank, you certainly do not want to validate the perception that inflation persistently missing its target is becoming tolerated. Simply because this would likely push term premia and long-end yields higher, undermining the very credibility the Fed is trying to restore. To put it simply, in our view the risk of policy error remains elevated, although admittedly, we are a bit in the dark, compliments of the absence of policy signals. Investors may wish to assess the role of duration carefully in the current environment.
Why today’s bond backdrop looks different from 2022
The last few weeks have understandably felt unsettling for global fixed income investors. Global monetary policy has shifted quickly as central banks confront sticky inflation. The ECB and Federal Reserve have signaled that further rate hikes may be needed, and futures markets now price roughly three hikes in the US and Europe by mid-next year, with even more expected in the UK, New Zealand and Canada. For bond investors, that naturally raises memories of 2022, when aggressive tightening drove one of the worst fixed income drawdowns in four decades. But we believe that this time the hiking cycle may prove more manageable. In 2022, policy rates started near zero and had to rise dramatically to counter inflation above 8% in many economies.
Today, inflation remains above target, but it is far lower than at the peak, and markets are pricing a far less extreme policy response. Bonds can also have more cushion. Yields are meaningfully higher than before, giving fixed income a better ability to absorb rate increases. The breakeven yield – a measure of how much rates would need to increase before wiping out a year’s worth of total returns – for the Global Aggregate Index was just 18 basis points at the end of 2021; today it is nearly 70 basis points, close to three rate hikes’ worth of protection. Valuations also appear attractive. With the Global Aggregate Index yielding around 4.25%, history suggests a solid starting point: since 2000, when yields have been within 25 basis points of today’s level, the median five-year annualized return has been 5.56%.[1] In our view, a milder hiking cycle, higher income cushion and stronger entry point may support the case for staying invested in fixed income (Contribution from David Peterson, Insights Analysis Lead Analyst).
[1] Source: Bloomberg. Current data as of 17 September 2026. Historical data from 31 January 2000 to 31 August 2026.
