Is the Fed heading for another hike? What changes for portfolios

The Federal Reserve’s next move could be another hike. In September the US central bank had already raised rates by 25 basis points, taking them to 3.75–4%. On 28 October it confirmed the target range for rates with ten votes in favour and two against. Lisa Cook and Beth Hammack would have wanted another quarter-point increase already at that meeting. On 12 November John Williams, president of the New York Fed, noted that there is still work to do to bring inflation back to 2%. As of 12 November, Reuters reported that markets were broadly expecting a hike of 25 basis points at the 8 and 9 December meeting, which would take the target range to 4–4.25%.

In October the consumer price index excluding food and energy rose by 0.3% on the month, as in September. The Fed defines its 2% goal on the basis of the PCE index. The CPI reading nevertheless provides an indication of the persistence of price pressures. November’s CPI will be released on 10 December, the day after the decision. On 9 December the Fed’s new projections will also be published, helping to show how widespread within the committee the expectation of further hikes in 2027 is.

Treasuries, risk is measured by duration

When a move is already expected, part of its effect has already been transmitted to prices. If the Fed were to raise rates by a quarter of a point and suggest that the level reached might be enough, the yield on the two-year Treasury could even fall. If, however, the projections pointed to further increases, the short end of the curve would have room to rise. At the long end, expectations for growth, the supply of public debt and the premium demanded by investors to tie up capital for longer also come into play.

The difference shows up in the numbers. All else being equal, if the market yield rises by half a percentage point, a bond with a modified duration of 7 loses about 3.5% of its price. With a duration of 2, the estimated loss is 1%. The calculation refers to the price, before coupons and changes in the exchange rate. Two securities from the same issuer can therefore react very differently to the same change in yields.

Dollar and equities, the risks for investors in euros

A hike can support the dollar if it widens the expected differential between US rates and those in the euro area. What matters is how much of that differential is already in prices. A Treasury may generate a positive yield in dollars and end up in loss in euros if the US currency weakens enough. For those using instruments with currency hedging, the comparison must be made on the yield net of the cost of the hedge.

The same distinction also applies in equities, through balance sheets. Higher discount rates weigh particularly on valuations that depend on earnings expected far into the future.

For indebted companies, what matters is how much debt will have to be refinanced over the next twelve or twenty-four months. Two companies in the same sector may have different prospects if one has locked in the cost of debt for years and the other must return to the market soon.

On 9 December the figure to watch will be the target range decided by the Fed. To assess the effect on wealth, it will be just as important to see how the two-year Treasury, the ten-year and the euro-dollar exchange rate react. Their response will show how much the market has changed its mind about the cost of money in 2027.

Sources for verification: Fed, September · Fed, October · FOMC calendar · BLS, October CPI · CPI calendar · Reuters, Williams and market expectations