Issue #2: Priced for Doubt

Last week, we saw the first rate hike since July 2023, a 25bp increasing the band from 3.5%-3.75% to 3.75%-4%, and the decision was unanimous, 12-0. The Fed Chair, Kevin Warsh, has said, "Inflation is too high and has been for too long," and that the committee will deliver "price stability." This matters because the Fed can't affect any individual price, like oil or groceries, but it can stop those price changes from spreading, helping avoid downstream second and third-order effects. By introducing this rate hike, the Fed can cool down this "high" inflation and guard against the energy shocks spreading into everything else.

But this is actually the least interesting fact of the week. We were already aware that a hike was priced at 90%. The news is the 'dot plot' (One dot represents one member): 16 out of 18 members expect at least one more hike this year. 4 see two more. Only 2 think one is enough. The odds for another hike this year went from 77% before Warsh's conference to 87% after. The dot plot is showing one more important thing this isn't a hiking cycle, it's a top-up. The Fed is raising to deal with the current inflation problem, but expects to reverse it once the energy shock passes. The committee is projecting rates to peak this year, hold in 2027 then drift towards 3% by end of the decade.

FOMC dot plot, September 2026 — Board of Governors of the Federal Reserve System

Looking at the 10y yield market it seems like its pricing something else, the 10-year yield closed at 4.995%. The Fed's dot plot reflects that rates will reach a maximum of around 4% this year, stay there in 2027 and begin to creep up to about 3% at the end of the decade. On the average, that's around 3.5%, so compared to the 10-year yield, it's about 150 bp difference. If this Fed's projection were true the market would want the 10-year to be 3.5% to 4%. It's at 4.995%.

Reasons why investors believe yields should sit near 5% :

Investors have no faith in inflation expectations. The Fed's current projections show PCE at 3.7% this year, falling to 2.3% next. That's a 1.4 percentage point drop in a year. If oil stays at $100 and the Strait stays closed, that's optimistic, so you demand more.
Lenders don't trust the rate path. If inflation doesn't fall as projected, the Fed won't be cutting as projected. It'll be holding or hiking again, so you price a high average.
Excessive amount of debt. The government has over $40 trillion in debt, to add on top of that, foreign buyers are stepping back. According to “Foreign Holdings of Federal Debt,” foreign buyers hold approximately 31% of U.S. Treasury debt. Japan now pays 1.25% at home after its Friday hike, so Japanese institutions are shifting to buy at home. More bonds, fewer buyers, so investors demand higher yields.

The Fed projections and the price of its own debt don't agree

Week: S&P +0.18%, Nasdaq +2.08%, Dow -1.31%, Russell -1.20%

A split is visible. The difference in the worst and best index this week was 3.4 points. It wasn't that anyone was running away from the market, it was only that they were moving within it. This week was a tough one for small caps as smaller companies tend to have floating bank loans, and large caps usually have fixed-rate bonds from years ago . The 10 year yield is 5% and yields dictate most things, whether it be mortgages or corporate borrowing rates. This 5% has more impact on small caps than large caps, meaning they can feel it in the interest bill in this quarter. Small companies depend on the funds borrowed to grow.

Why did Big Tech go up? The usual outlook would be that growth stocks should suffer more from these higher rates because their value sits on profits in the future, and higher interest rates directly discount them, but that did not happen this week. This is because big tech companies are sitting on enormous cash piles, and they generate way more than they spend. When borrowing costs 5%, a company that doesn't borrow has an advantage over one that does, and investors are willing to pay a premium for that. Chip makers specifically grew. Investors are choosing wisely where to put their cash, and yields are at the top of that decision.

Global

The highlight of the week was a 25BP increase by the BOJ to its 1.25% rate, the highest in 31 years. The increase was widely anticipated but the most interesting was the message, which was less hawkish than expected. Governor Ueda seemed to keep the door open for more hikes, but the interesting part to notice was the yen, which actually weakened. In Europe, the BOE left the rate unchanged at 3.75%, but 3 out of 9 BOE members preferred a rate raise, indicating that inflation continues to be a concern for policy makers. The other concern was China, which is still facing a dilemma: strong industries but weak internal demand, as retail sales slowed to just 0.4%.

The regional and global levels are also seeing AI become a geopolitical topic, as governments are urging more coordination and regulations over the technology at the UN, stating issues such as loss of control, deceptive behavior, information pollution, and far more. So the world is increasingly split central banks continue to worry about inflation, China is struggling with demand, and governments are making technology a top concern.

UAE/Gulf Desk

Recovery is a 2027 story

The big question I posed last week was: how's the Saudi pipeline going to recover? That's now been answered, and it doesn't look good. The damage from last week's Saudi pipeline attack turned out to be worse than first thought, and repairs will take weeks at minimum. Hormuz is still mostly shut, although 'dark' shipments are continuing to increase, as shippers attempt to secretly pass through the strait. The Houthis, emboldened by successes, are continuing to escalate. The Gulf is holding its breath, and that's why oil remained above $100 all throughout last week.

Satellite imagery shows noticeable damage to pipeline facilities in Saudi Arabia, Reuters

The Fed's rate hike sent ripples through the Gulf, as all central banks (excluding Kuwait) raised their benchmark rates accordingly. With one more hike likely this year, that weighs on property, consumer lending, and stock valuations. For the UAE, Saudi, Oman, and Qatar, it was a 25 bps hike, in direct line with the Federal Reserve's move. In plain terms, mortgages, loans, and credit cards in the Gulf are going to get more expensive.

The oil-rich emirate has stood to gain from high oil prices and the Fujairah pipeline, bypassing Hormuz. Abu Dhabi markets were seen higher broadly throughout the week, as Dubai's market softened as tourism, aviation, and property drag.

Looking ahead, a diplomatic breakthrough in New York on Tuesday at the UN General Assembly, where Hormuz re-opens, Western airlines return, and Dubai recovers, would be an enormous positive development for Gulf markets. On the other hand, continued escalation from the Houthis, or further Iraqi strikes, would invite more Fed hikes, and keep the pressure on Gulf economies. The UAE and Saudi are adapting through their in-land pipelines, but Kuwait, Qatar, and Bahrain have no alternative export route.

With the war dragging on, the deadline has now passed in order for a normalisation in the Gulf's energy industry to finish by year's end. ADNOC's CEO said it would take at least four months to ramp up oil flows up to 80% of normal, with full normalisation not until the first or second quarter of 2027.

Given Trump's own comments, and what we've seen in the last six months, it's pretty clear the war won't be ending in the immediate future. For now, Gulf economies are going to keep trying to adapt, building new export routes, and trying to navigate the persistent drag from trade disruptions to elevated borrowing costs.

Priced for Doubt

US/Global Desk

The Dot Plot

UAE/Gulf Desk

Recovery is a 2027 story