Repricing and Resilience

September proved an eventful month for investors. The US saw its first interest rate hike in more than three years, while oil prices moved higher amid heightened uncertainty surrounding the conflict with Iran. Meanwhile, Chinese President Xi Jinping made his first visit to the White House in over a decade. Against this backdrop, global government bond yields repriced sharply higher, yet equity markets demonstrated remarkable resilience, supported in part by continued enthusiasm around AI.

On 16 September, the Federal Reserve (Fed) voted unanimously to raise interest rates by 0.25% to a target range of 3.75%–4.00%. Chairman Kevin Warsh highlighted that inflation has remained above the Fed’s 2% target for an extended period, while economic growth has continued to prove resilient. Purchasing Managers’ Index data provide a timely indication of economic activity, with a reading above 50 signalling expansion and below 50 indicating contraction. The US recorded an exceptionally strong reading of 58.4 in September, the highest since July 2021. The underlying data pointed to a broad-based acceleration in private-sector activity, helping to alleviate lingering concerns over the global growth outlook. Further evidence of economic strength came from robust retail sales, reinforcing the case for the Federal Reserve’s decision to raise rates. The Fed’s latest projections point to one further rate increase over the coming months. However, investors are increasingly considering the possibility of a more sustained tightening cycle should economic activity remain resilient and inflationary pressures persist. This shift in expectations drove a sharp rise in US government bond yields during September and an appreciation of the US dollar which benefited UK investors allocated to US stocks.

While the repricing of bonds has been particularly notable in the US, it has very much been a global phenomenon. Persistent tensions with Iran have driven oil prices higher once again, adding to inflationary pressures and contributing to rising government bond yields across global markets. Reports suggest that flows through the Strait of Hormuz have partially recovered, but with hostilities ongoing, risks to energy supply remain elevated. Higher oil prices represent a particular headwind for Europe, given its reliance on imported energy, and contributed to weakness in European equities during September. Within bond markets, political and fiscal concerns have added further pressure. With France approaching its 2027 presidential election, the government is struggling to secure support for measures aimed at reducing public spending. Investors are therefore increasingly focused on the pace at which France can stabilise its debt trajectory. Reflecting these concerns, the spread between French and German 10-year government bond yields widened materially during September, exceeding 1% and reaching its highest level since 2012. In the UK, government bond yields remain higher than those in the US and much of Europe. However, UK Gilts outperformed during September, perhaps suggesting that a significant degree of investor concern surrounding the UK’s fiscal and political outlook is already reflected in valuations. Attention will now turn to the UK Budget on 28 October, which could provide the next catalyst for the market. Finally, while most government bond investors suffered losses during September, some more specialist areas of fixed income, including asset-backed securities, delivered modest positive returns. This divergence once again highlights the importance of fund selection when allocating to fixed income, particularly during periods of heightened interest-rate and market volatility.

Despite the sharp repricing of interest-rate expectations and ongoing tensions in the Middle East, equity markets proved remarkably resilient during September, supported by continued enthusiasm surrounding AI. The Trump-Xi meeting also provided reassurance, with the two countries extending their existing trade truce and agreeing to establish a formal dialogue on AI ‘superintelligence’. Meanwhile, Meta’s launch of Muse in the US on 8 September provided a further catalyst for AI-related stocks. Muse is designed as an autonomous personal AI agent, capable of carrying out tasks such as booking travel, sending emails and completing transactions, rather than simply generating responses. With subscriptions costing up to $100 per month, the product provides a tangible route towards consumer monetisation of the significant capital being invested in AI infrastructure. This is particularly important given growing investor scrutiny over whether the substantial levels of AI-related capital expenditure can ultimately generate sufficient returns. Early indications of consumer demand have been encouraging, with estimates suggesting that Muse surpassed three million downloads within just a few weeks of its launch. Meta shares rose by more than 25% during September in response. Strength across AI-related stocks more broadly provided a tailwind for equity markets in the US, Japan and parts of emerging markets, with the Nasdaq reaching a new all-time high during the month.

Bottom Line

September was characterised by a sharp sell-off in bond markets, alongside remarkably resilient equity markets. Rising interest rates and higher energy costs present growing headwinds for risk assets, although robust economic data and continued momentum in AI-related investment are providing reassurance. Against this backdrop, the pace of AI investment and adoption, and increasingly its ability to translate into sustainable earnings and monetisation, will remain an important area for investors to monitor.

Q&A

A Shifting Yield Curve

Much of the previous discussion has focused on bond yields and the broad repricing of interest rates that took place in September. To explore this further, it is useful to consider the US yield curve, which shows the yields on US Treasury securities across different maturities. The curve provides insight into the government’s cost of borrowing over different time horizons, while its shape can also offer clues about market expectations for interest rates and future economic activity. The chart below shows the US yield curve at the end of June and September, with the broad repricing of interest rates clearly visible. The sharp rise at the front of the curve reflects a significant increase in the expected path of interest rates, as investors priced in further rate rises in response to renewed inflationary pressures and a resilient US economy. Further along the curve, the rise is more gradual, reflecting expectations that inflation and interest rates should moderate over time. Longer-term yields have also risen, as concerns over the US fiscal position and heavy government borrowing coincide with substantial AI-related investment, increasing competition for capital and putting upward pressure on borrowing costs. Overall, September saw yields move materially higher across the curve, reflecting both a higher expected path for interest rates and broader pressure on the cost of long-term capital.