FED Pivots back to Restrictive Policy
October 5, 2026
By Mitchell Anthony
Overview
The Federal Reserve has become unhappy with the current level of inflation. The Fed action comes after more than two years of waiting for consumers to balk at the level of current prices, consumers however continue to spend despite constant complaints and the Fed has had enough.
The Fed stayed on hold for quite a while because of his belief that the Inflation is more cost push than demand pull but regardless the Fed will not tolerate the current level of inflation and has elected change course of past policy.
The bond market has been a house of pain for some time as rates have been rising steadily since 2022. With the Fed’s current action bond, investors again became sellers and Interest rates have risen in the market in anticipation of a policy that pushes rates about one hundred basis points higher over the next year.
The rising rates are a slap in the face of corporate borrowers who had been expecting relief after a sharp rise in rates in 2022 that hindered private credit markets and slowed down the pace of investment banking and LBOs.
Last Quarter
The third quarter was a much more selective market than the second. U.S. large-cap equities remained positive, but leadership narrowed sharply to mega Cap Stocks as small caps and emerging markets lost favor. Technology continued to benefit from extraordinary spending on AI compute, networking, memory and data-center infrastructure, while energy also strengthened. Financials, real estate, utilities and consumer-sensitive areas were more mixed.
The economic backdrop remained solid but inflation again became the key constraint. August CPI rose 0.4% month over month and 3.4% from a year earlier. Core CPI was 2.4% year over year. The labor market remained steady, with August payrolls increasing by 162,000 and unemployment holding at 4.1%.
The Federal Reserve responded to the firmer inflation picture by raising the federal-funds target range by 25 basis points to 3.75%-4.00% on September 16. The Fed described economic activity as expanding at a solid pace, with resilient domestic spending, strong productivity and robust capital investment.
For investors, the quarter reinforced the importance of earnings durability. The broad S&P 500 remained positive, but sector dispersion widened considerably. AI-linked technology retained leadership, while energy benefited from a stronger commodity backdrop. Higher rates created a tougher environment for rate-sensitive assets.
Economic Review Q3 2026
The economy entered the final month of the quarter with a stable labor market and continued strength in investment. August payroll growth of 162,000 was consistent with an economy still expanding, while the 4.1% unemployment rate remained low by historical standards. The more difficult issue was inflation. Headline CPI accelerated in August as gasoline prices rose, while core inflation remained above the Federal Reserve’s 2% objective.
The September rate increase changed the tone of the quarter. Fixed income investors continue to feel pain as bond prices tilted downward as rates tilted upward. Resilient demand, robust capital spending and sticky inflation – supports nominal growth but also keeps pressure on longer-duration assets and rate-sensitive sectors.
Consumer demand and business investment remained supportive, while AI-related capital spending continued to create a powerful investment cycle across semiconductors, networking, electrical equipment, power generation and data-center cooling. The renewed rise in inflation, however, reduced the probability of an easy path toward lower interest rates. As a result interest sensitive parts of the market felt pain. Housing cannot seem to catch a break.
Financial Market Review
The S&P 500 produced a modest 2.3% total return during the third quarter, a sharp slowdown from the second quarter. MACM’s dynamic growth portfolio had a great quarter advancing 4 ½% or more than double the return of the S&P 500. Technology remained the strongest structural growth area, supported by AI infrastructure demand. Energy strengthened materially. Healthcare improved, while utilities, real estate, industrials and consumer discretionary weakened from their mid-year levels. The exception was shopping center reads experience one of the best quarters and years as retailer’s interest in these properties rebounded and the lack of new supply created a better demand situation.
International equities were mixed, with broad global markets positive but Europe softer late in the quarter. The quarter again demonstrated that investors remain willing to pay for durable secular growth, but the market became more selective as interest rates moved higher.
The strongest areas of the market continued to be businesses with improving expectations tied to AI infrastructure, compute demand and energy. Higher rates were a headwind for rate-sensitive areas of the market and made valuation increasingly important.
Economic Outlook
With interest rates rising and the Fed turning to restrictive policy, investment managers must think about whatever rot might be brewing in the economy and is it significant enough to bring about a bust! We have been vigilant about looking for rot in the economy as we have enjoyed the significant returns we have experienced in the equity market. There is nothing significant to report but we are aware that the private credit markets are feeling some distress due to the rise in short-term interest rates over the last three years. As a result, leverage buyouts have slowed down as investors have not had access to cheap capital to conduct investment banking operations to make these things happen. The businesses that have consumed large amounts of private credit at near double-digit interest rates are concerning but the mix is highly diversified with no sector of the economy seemingly overextended. We continue to monitor the situation closely and will cut equity exposure significantly at the first sign of a bust in the credit markets.
The U.S. economy still appears capable of expanding, but the mix is less comfortable than it was in the spring. Consumer demand and business investment remain supportive, while AI-related capital spending continues to create a powerful investment cycle across semiconductors, networking, electrical equipment, power generation and data-center cooling.
At the same time, the renewed rise in inflation has reduced the probability of an easy path toward lower interest rates. The economy remained resilient through August, but inflation and monetary policy became more restrictive.
The major themes of consumption and investment remain intact. Artificial intelligence and compute capacity, digitization of data, entertainment and leisure, e-commerce and healthcare should continue to support economic activity. The industrial economy also continues to benefit from the enormous amount of capital being invested in data centers and related infrastructure.
Financial Market Outlook
We continue to believe equities are better positioned than many other risk assets, but yields in the bond market are starting to look more and more attractive and equity investors could cut and run at the first sign of a bust in the economy. Valuations and interest rates matter more after the strong first half of the year. Earnings growth, productivity and the AI capital-spending cycle continue to support the equity market.
The market may remain unusually selective. Companies that can convert AI demand into revenue, margins and free cash flow should continue to be rewarded, while businesses relying primarily on multiple expansion may have a more difficult time.
Technology’s leadership remains substantial, but the third quarter also showed that leadership can broaden into areas such as energy and healthcare. Conversely, utilities and real estate remain vulnerable when rates move higher. Fixed income faces a more difficult setup following the September increase in interest rates, particularly at the longer end of the curve.
Our objective is to continue to hold companies and industries where it is reasonable for expectations to move higher or at worst hold their current level of expectation. This includes the areas noted above.
We remain optimistic!