First Fed rate hike in years: What it may mean for investor portfolios

The U.S. Federal Reserve just hiked interest rates for the first time since July 2023, and the implications for portfolios could be significant.¹ Advisors and investors alike are asking: How should I position for rising interest rates?

Key takeaways

• The Fed raised interest rates for the first time since July 2023, facing sticky headline inflation, higher energy prices, and a steady labor market.
• We believe elevated risk-free rates (the return investors can earn on very low-risk government debt, such as U.S. Treasuries) and real yields (the return on an investment after accounting for inflation) provide an attractive starting point for fixed income returns in this current environment.
• We remain strongly convicted in equities, which can still do well in higher-rate regimes, particularly if rate volatility stays contained. We favor higher-quality companies, large caps and dividend payers, over more rate-sensitive small caps.
• We emphasize the value in diversifying beyond traditional bonds into other asset classes such as alternatives, as correlations between stocks and bonds have become unreliable in recent years.

The Federal Reserve is hiking interest rates

At its September meeting, the Fed increased interest rates by 0.25% to a range of 3.75% to 4.0%, Facing sticky headline inflation, geopolitical conflicts leading to elevated energy prices, and a resilient labor market, this marks the first significant rate decision of Chair Kevin Warsh’s tenure since he took over in May 2026.

• Inflation has remained sticky above the Fed’s 2% target, with February 2021 marking the last time year-over-year growth was below target.² While core inflation has followed a pattern of cooling, the headline reading has reaccelerated, driven largely by elevated energy prices.
• In the labor market, the unemployment rate held steady in August at 4.1%.³ Nonfarm payrolls were triple the expected number (162k vs. 53k), marking a substantial acceleration from the prior 12-month average, in which hiring has been concentrated in the healthcare, education, and hospitality sectors.⁴

While this hike is significant, we don’t believe this is the start of an aggressive hiking cycle. Our baseline scenario is one more hike in 2026 as the Fed seeks to reduce inflation at “sufficient speed.” Warsh has emphasized his intention to provide less forward guidance, but a demonstrated commitment to bringing inflation back towards target could help contain inflation expectations and support longer-term bonds. The committee noted that the forward path of rates has become less certain, with the current Fed funds futures pricing in 4.25% by year-end.  

Warsh made clear in the post-decision press conference that his primary focus is bringing inflation back towards the 2% target. He said he views the labor market as running nearly at full employment, and does not see the rate increase as inherently damaging to the resilient jobs market. He also mentioned that a strong economy, competition for capital, and geopolitics are the primary forces driving long-term yields higher.

Given this backdrop, we see opportunities for investors to put cash to work, potentially allocating to floating rate exposures, managing interest rate risk with intermediate maturities, building bond ladders, and seeking higher income outside of core bonds.

Here’s what we’re watching, and where we see opportunity.

Figure 1: Initial rate hikes are not inherently negative for stocks or bonds
1-year returns for stock and bond categories following the start of seven Fed rate hiking cycles from 1983 to 2022

Where do we see opportunities in fixed income as rates rise?

Elevated risk-free rates and real yields provide an attractive starting point for fixed income returns. With investment-grade and high-yield spreads historically tight, we favor clipping coupons while remaining selective on credit risk, with a preference for investment-grade and higher-quality speculative-grade bonds. Securitized and real asset-backed credit may also offer attractive income and resilient cash flows, while emerging market debt continues to benefit from supportive carry, resilient growth and improving flows.

We see scope for further yield curve steepening as heavy Treasury and corporate issuance compete for capital, while policy uncertainty could keep risk premia elevated. This argues for a nimble approach to duration, though opportunities remain further out the curve. With 30-year TIPS yields above 3% and real yields elevated across maturities⁵, TIPS offer meaningful income and potential protection against weaker growth, while positioning in inflation-mitigating assets remains relatively light.

Figure 2: Yields have risen YTD, and are attractive compared to cash and core bonds

What do higher rates mean for equities?

Equities can still do well in higher-rate regimes, particularly if rate volatility stays contained. With U.S. equity valuations in-line with historical averages (19x 12m forward PE), we remain convicted in U.S. stocks, as we explain in our Fall 2026 Investment Directions.⁶ Micro fundamentals remain strong, with Q2 earnings growth for the S&P 500 at 31% (on an adjusted basis), even as macro dynamics become incrementally more challenging.⁷ Still, higher rates make us more selective. Within equities, we favor higher-quality companies, large caps and dividend payers, over more rate-sensitive small caps.

Figure 3: U.S. stocks have historically continued higher 12 months after the start to Fed rate hiking cycles

What does the Fed rate hike mean for investor portfolios?

The Fed’s rate hike reinforces that inflation remains the key concern, creating both opportunities and risks across portfolios. Higher yields can improve the return potential of bonds, and stocks can still perform well if economic and earnings growth remain resilient, although markets may face greater volatility as investors adjust to a higher-rate environment.

We believe that investors should look to diversify their diversifiers. Since 2020, stock and bond correlations have been 0.51, up from -0.22 from 2010-2019, making the traditional 60/40 portfolio less dependable as a source of diversification.⁸ Adding alternatives, including liquid alternative strategies with different return drivers, may help reduce reliance on stock and bond correlations and build greater portfolio resilience across changing inflation and interest-rate environments.

How can I diversify my portfolio beyond bonds?

The past few years have shown how valuable diversifying beyond traditional bonds can be for investors, as correlations between stocks and bonds become unreliable and the Fed has shifted focus to addressing elevated inflation. Strategies such as the BlackRock Global Equity Market Neutral Fund (BDMIX) and BlackRock Tactical Opportunities Fund (PBAIX) have delivered consistently positive returns with low correlations to equities across 6 distinct rate cycles since 2022, as shown in Figure 4.

Figure 4: Liquid alternatives have delivered consistent returns across rate cycles

Advisor playbook: How to position portfolios amid higher rates

With rates likely to remain elevated, now may be a good time to reassess portfolios.

Three key actions to consider:

1. Reevaluate bond allocations. We favor carry, with deliberate duration positioning and credit exposure.
2. Add diversification with alternatives to help manage volatility and potentially drive higher returns in uncertain rate environments.
3. Maintain equity exposure, favoring higher-quality and large cap companies over rate-sensitive small caps.

The opportunity set has shifted quickly, and the investors who are nimble may be best positioned to benefit.

Stay ahead with the monthly Advisor Outlook, where we share timely insights and portfolio strategies as the rate-cut cycle unfolds.