The Fed faces a difficult balancing act. Raise rates too aggressively, and it risks weakening an economy already absorbing higher costs. Do too little, and inflation could become a more persistent problem. At the beginning of the year, we identified reaccelerating inflation as the greatest risk to markets, and this week's reports reinforce that concern. Fortunately, the risk isn't a surprise, and we've been positioning portfolios accordingly. This week's rotation across equity sectors and styles is a timely reminder of why diversification matters, particularly as the Fed attempts to bring inflation down without unnecessarily sacrificing economic growth.
The Fed has a problem it is fighting with both hands tied behind its back. Following September’s 0.25% interest rate hike, this past week’s inflation reports confirmed that price pressures continue to move higher. Consumer price inflation rose 0.6% in September, bringing annual CPI to 3.7%, and producer price inflation climbed an even higher 6.3% year-over-year.
Inside the CPI number shows more than half of the increase was attributable to energy prices, with gasoline prices alone rising 9.1%. Rising producer prices can eventually make their way to end consumers as businesses choose to pass along costs in the form of higher prices, adding to CPI inflation pressures in the months ahead.
This has created the problem for the Fed of fighting inflation, driven in large part by a supply shock, with a monetary policy tool designed to reduce demand.
Higher energy prices are problematic for more than just the glaring pain at the pump. Rising diesel and other fuel costs increase transportation and distribution costs throughout the economy. Businesses can either choose to absorb the costs and lower profit margins or pass them to you and me in the form of higher prices, potentially fueling more inflation.
The Fed’s traditional response in these situations has been to raise interest rates. In theory, raising borrowing costs should discourage spending and investment, reducing demand, leading to a reduction in prices, and thus easing inflation. But our complicated economy isn’t as simple as your microeconomics 101 course. Higher interest rates cannot produce more oil or resolve geopolitical disruptions in global energy supplies.
Consider that, while both interest rates and producer prices rose in September, so too did industrial production, which increased 0.7% month-over-month. In fact, it’s the highest year-over-year reading since September 2022. The economy continues to produce more, even as rising energy input prices put pressure on both businesses and consumers.
Of course, inflation isn't exclusively an energy problem. Prices outside the energy sector are also increasing, giving the Fed reason to remain cautious. Still, energy accounts for much of September's acceleration, and monetary policy designed to suppress demand risks creating additional headwinds without addressing the underlying supply disruptions; but for now, the economy is producing more in the face of those higher cost pressures.
Warsh’s Fed has now reversed one of three 25 basis point cuts delivered during the final months of Powell’s tenure at the end of 2025, setting the Fed funds target at 3.75 – 4.00%.
Another two 25 basis point hikes would return rates to their September 2025 level. But returning there doesn't necessarily mean returning to neutral monetary policy. That depends on where the neutral rate sits today, a question Warsh will be reluctant to address through forward guidance, which ironically is his favorite thing to talk about. Without a clear understanding of neutral, the Fed risks restricting an economy already absorbing higher costs.
Meanwhile, U.S. equity markets experienced a noticeable rotation this week. While the S&P 500 index moved modestly, different investment styles and sectors told a different story. Technology and large-cap growth stocks experienced meaningful selling pressure, while value and defensive sectors, including healthcare and consumer staples, attracted renewed investor interest:
|
Sector |
Ticker |
1 Week Performance |
|
Healthcare |
XLV |
5.37% |
|
Consumer Staples |
XLP |
3.91% |
|
Real Estate |
XLRE |
2.79% |
|
Materials |
XLB |
2.62% |
|
Energy |
XLE |
2.02% |
|
Financials |
XLF |
1.92% |
|
Consumer Discretionary |
XLY |
1.52% |
|
Utilities |
XLU |
1.41% |
|
Communications |
XLC |
0.33% |
|
Industrials |
XLI |
-0.30% |
|
Technology |
XLK |
-4.34% |
Source: YCharts. One-week performance through October 15, 2026.
The rotation reminds an important point: that leadership is rarely permanent. Higher borrowing costs and changing economic conditions create opportunities elsewhere. For those who tuned into our Outlook presentation at the beginning of the year, you’ll remember we identified a reacceleration of inflation as the primary threat to markets in 2026:
This week's inflation reports reinforce that concern, but the risk is not a surprise. We've been positioning portfolios with this possibility in mind rather than waiting for it to materialize. Our emphasis on diversification across sectors, styles, and geographies is intended to help navigate these shifts in market leadership and identify opportunities as they emerge.
The Fed faces a difficult balancing act. Raise rates too aggressively, and it risks weakening an economy already absorbing higher costs. Do too little, and inflation could become a more persistent problem. At the beginning of the year, we identified reaccelerating inflation as the greatest risk to markets, and this week's reports reinforce that concern. Fortunately, the risk isn't a surprise, and we've been positioning portfolios accordingly. This week's rotation across equity sectors and styles is a timely reminder of why diversification matters, particularly as the Fed attempts to bring inflation down without unnecessarily sacrificing economic growth.
Enjoy your Sunday!
- Matt
Matt Gentzkow CIMA®
Managing Director, Wealth Advisor
Matt Gentzkow is Managing Director and Wealth Advisor at Coastal Bridge Advisors, where he shares his insights with the investment committee and guides clients toward their financial goals. Before joining the firm, he held advisory and wealth strategy roles at UBS and Morgan Stanley. Matt earned bachelor's degrees in finance and economics from Xavier University and is a Certified Investment Management Analyst® (CIMA®). His market insights have been featured in publications including The Wall Street Journal and Kiplinger.
Sources: Ycharts, Forbes, Bureau of Labor Statistics, Federal Reserve Bank of St. Louis
The views and opinions expressed are those of Matt Gentzkow, CIMA® as of the date of publication and are subject to change without notice. This material is provided for informational and educational purposes only and is not intended to constitute investment advice or a recommendation to buy or sell any security. The information and opinions expressed are based on sources believed to be reliable, including third-party sources, but are not guaranteed as to accuracy or completeness. Third-party information has not been independently verified by CBA. Any forward-looking statements or hypothetical examples are for illustrative purposes only and are subject to change based on market and economic conditions. Past performance is not indicative of future results.