How far will the Fed go?

The Federal Reserve changed direction on September 16, raising its target range by a quarter point in its first rate hike since 2023. However, the bigger story is not the 25 basis points. It is that the easing cycle is over, and the burden of proof has flipped. The question now is how far the Fed may ultimately need to go.

Markets expect a mild hiking cycle

For now, investors are expecting a relatively modest move higher in rates. As of September 23, futures markets were pricing in almost two additional quarter‑point hikes by year‑end, and just over four hikes in total through the end of 2027.

In other words, markets appear to expect something closer to a midcycle adjustment than a full‑fledged hiking cycle. That could certainly prove correct. But history suggests investors may want to take that assumption with a grain of salt.

History suggests caution

The modern era of Federal Reserve policymaking began in February 1994, when the Fed started announcing rate changes on the day they were made. Since then, there have been six hiking cycles. Only one turned out to be a true mid‑cycle adjustment.

In the other five cases, the federal funds rate ultimately rose at least 175 basis points from where the hiking cycle began. The exception was 1997, when the Fed raised rates only once before reversing course. But even that episode proved temporary. After three subsequent cuts, the Fed began hiking again in 1999—a cycle that ended about a year later when the technology bubble burst.

While the current futures curve may prove accurate, history suggests that once the Fed has started hiking, the endpoint has often been considerably higher than markets initially expected.

The Fed is only part of the story

More importantly, Fed policy has become a less important driver of longer‑term Treasury yields. Over the two years ended September 23, 2026, the 10‑year U.S. Treasury yield increased from roughly 3.73% to 5.10%—an increase of about 137 basis points.

Only about 72 basis points of that move can be attributed to higher expectations for future Fed policy. The remainder reflects an increase in the term premium—the additional compensation investors demand for holding longer‑term bonds. That premium has risen for a variety of reasons, including greater geopolitical uncertainty, persistent inflation concerns, heavy Treasury issuance, and expectations for rising capital expenditures globally.

Those pressures are unlikely to disappear simply because the Fed ultimately delivers a relatively modest hiking cycle. As a result, even if markets are correct about the path of Fed policy, longer‑term yields could continue to grind higher.

Limited reward for taking duration risk

At the same time, investors currently are receiving relatively little compensation for taking additional duration risk. As of September 23, the two‑year Treasury yielded 4.85%, compared with 5.10% for the 10‑year and 5.40% for the 30‑year. That means investors would receive only 25 additional basis points for extending from two years to 10 years—and roughly 56 basis points for extending all the way to 30 years. Those yield pickups appear relatively modest given the significantly greater sensitivity of longer‑duration bonds to changes in interest rates.

Conclusion

The Fed may ultimately deliver the relatively mild hiking cycle currently embedded in futures markets. But history suggests that outcome should not be taken for granted. More importantly, the rise in longer‑term yields increasingly reflects forces beyond Fed policy—particularly the higher term premium. With those structural pressures still in place, and relatively little additional yield available for taking duration risk, our Asset Allocation Committee continues to maintain a short duration stance in fixed income.