Last week's Federal Reserve meeting left many investors asking the same question: Why did both stocks and bonds decline so sharply? While the Fed left interest rates unchanged, the market's reaction had less to do with what policymakers said and more to do with what they didn't say.
Federal Reserve Chairman Kevin Warsh has signaled a shift in how the central bank communicates with markets. Rather than providing detailed forward guidance, Warsh has encouraged investors to focus on incoming economic data instead of trying to interpret every statement from the Fed. Policymakers also discussed the possibility of reducing the number of Federal Open Market Committee meetings each year, reinforcing the idea that the Fed intends to speak less frequently about future policy.
While that philosophy has its merits, it also creates uncertainty. Investors broadly understand the Fed's goal of returning inflation to its 2% target. What remains less clear is how policymakers will respond if inflation proves more persistent than expected. Without a clear framework explaining what economic conditions would justify raising, holding, or lowering interest rates, markets are left to fill in the gaps themselves.
That uncertainty contributed to a sharp rise in Treasury yields following the meeting. Some investors concluded that interest rates could remain elevated for longer—or even move higher if inflation doesn't moderate. As Treasury yields climbed, both bond prices and stock valuations came under pressure. The 10-year Treasury yield now sits around 4.7%, while the 30-year Treasury has risen above 5%, approaching its highest level in nearly two decades.
Higher interest rates extend far beyond financial markets. Mortgage rates have climbed to their highest level in about a year, keeping home purchase activity well below the levels seen before and immediately after the pandemic. Businesses are also facing higher borrowing costs, particularly technology companies investing heavily in artificial intelligence infrastructure. As financing becomes more expensive, companies may face greater pressure on future investment decisions and profit margins.
Rising yields also tend to have a greater impact on growth-oriented stocks because much of their expected value comes from earnings projected years into the future. As interest rates increase, those future earnings become less valuable in today's dollars, contributing to the volatility investors have seen in many AI-related companies.
While the future path of interest rates remains uncertain, the broader investment lesson has not changed. Diversification continues to play an important role when market conditions become less predictable. By maintaining a balanced portfolio rather than concentrating heavily in a single theme or sector, investors can better navigate periods of uncertainty while remaining focused on their long-term financial goals.
Often quoted in major national media, Adam is a Chartered Financial Analyst (CFA®), a CERTIFIED FINANCIAL PLANNER™ (CFP®), and has been included on the Forbes NextGen Best-in-State Wealth Advisors 2019 list. He is a member of the CFA Society of Los Angeles and the CFA Institute. Adam helps establish asset allocation strategy as a member of the EP Wealth Investment Committee, which supports all EP Wealth Advisors and their clients. The Committee’s top-down approach to portfolio construction begins with an outlook on the economy’s likely direction, followed by the implications for different economic sectors and asset classes. This culminates in strategic selection of the individual stocks, bonds, mutual funds or other investments deemed most appropriate for each individual client’s portfolio.
EP Wealth Advisors offers a comprehensive range of services to help you invest with greater insight, as well as develop a holistic wealth management strategy. To discuss your finances and investment goals, we invite you to contact one of our advisors.
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Video Transcript:
Adam Phillips:
I had a conversation with a client last week who's a regular viewer of these market updates. They asked a great question: Why did both stocks and bonds sell off so sharply after Wednesday's Federal Reserve meeting?
I think the answer has less to do with what the Fed said, and more to do with what it didn't say.
Under Chairman Kevin Warsh, the Fed has intentionally shifted its communication strategy. Warsh has argued that the Fed has spent too much time providing forward guidance and wants markets to "play the ball, not the referee." In other words, focus on the economic data rather than trying to interpret every word coming out of the Fed.
He's also suggested the Fed doesn't need to communicate as frequently, and one topic discussed at last week's meeting was even the possibility of reducing the number of FOMC meetings from eight per year to six.
That's a perfectly reasonable philosophy. But it leaves investors asking an important question:
If inflation doesn't cooperate, what exactly will the Fed do?
Torsten Slok, who serves as Chief Economist at Apollo Global Management, captured the issue with a great analogy. He said it's like someone saying,
"I'll take you from New York to Los Angeles, but I'm not going to tell you how quickly we'll get there, what it'll cost, or how we're getting there."
You'd probably start wondering whether you're actually going to make it to Los Angeles.
That's essentially where markets are today.
Investors still believe the Fed is committed to restoring inflation to its 2% target. They understand the destination. What they don't understand is the roadmap.
Now, I can honestly argue both sides of whether the Fed should raise rates from here. There are valid arguments on each side. That's not really the issue.
The issue is that markets function better when they understand the Fed's reaction function—what economic conditions would actually cause the Fed to raise rates? What would keep rates unchanged? What data would convince policymakers that higher market interest rates are doing enough of the work?
In fact, during last week's press conference, Warsh suggested that higher market rates are already tightening financial conditions, reducing the need for the Fed to do additional tightening itself.
Markets don't need the Fed to promise anything. But they do need a framework for understanding how decisions will be made.
Without that framework, investors are forced to fill in the blanks.
And that's exactly what happened after last week's meeting.
Some investors concluded that rates could remain higher for longer—or even move higher if inflation remains stubborn. That uncertainty pushed Treasury yields sharply higher, and because higher yields affect both bond prices and stock valuations, we saw both asset classes decline together.
Today, the 10-year Treasury is around 4.7%, while the 30-year Treasury has climbed above 5.2%, approaching the highest levels we've seen in nearly two decades.
Those higher yields matter because they ripple through the entire economy.
For households, mortgage rates have climbed to their highest level in about a year. Mortgage purchase applications remain roughly half of where they were during the late 2010s, and well below the levels we saw during the post-pandemic housing boom.
Businesses are also feeling the effects.
One area we're watching closely is artificial intelligence investment. Goldman Sachs estimates that hyperscale technology companies could issue roughly $400 billion of new debt globally next year to finance AI infrastructure. When borrowing costs rise, funding those investments becomes more expensive, which can eventually pressure margins and investment decisions.
Higher yields also have an important impact on stocks—particularly growth companies whose earnings are expected further into the future.
Those future cash flows become less valuable as interest rates rise, which creates additional pressure on valuations. That's one reason we've seen increased volatility in many of the companies tied to the AI buildout.
It's also one of the reasons we've continued to emphasize diversification.
We don't know exactly where rates go from here, and we don't know exactly how the Fed will respond to future inflation data. But we do know that concentrating too heavily in one theme or one part of the market can create unnecessary risk when the outlook becomes less certain.
We'll continue watching both the economic data and, just as importantly, how the Fed communicates its strategy going forward.
Because the destination—price stability—isn't really what's in question.
The roadmap is.
Thanks for watching, and I'll see you next week.