A Market of Two Minds

Wall Street has an old saying, the market climbs a wall of worry. Right now it cannot decide which side of the wall it is on. On any given day, investors treat the same economic data as proof the economy is strong enough to absorb a rate hike, or as evidence that higher borrowing costs will choke off growth. The result is a market of two minds, lurching between optimism and anxiety with every headline.

Since Kevin Warsh assumed the chairmanship of the Federal Reserve, he has adopted a new communication policy or, more accurately, a policy of minimal communication with the investment community. The Fed's relative silence is causing investors to experience wild mood swings, as indicated by the daily volatility of their stock trading. Analysts are swinging between extremes as they search for clues about what the Federal Open Market Committee (FOMC) may decide at each meeting on interest rates. The FOMC's next meeting concludes next Wednesday, September 16.

We discussed this silent treatment by Fed Chairman Warsh in our July 22 UPdate, "Wall of Worry, Inflation and Interest Rates".

With little guidance from Chairman Warsh, market participants have resorted to soliciting comments from individual Fed governors and attempting to determine how each member may vote. Every new statement seems to rattle the markets in one direction or the other.

The CME Group's FedWatch Tool provides continuously updated probability estimates that resemble the odds offered by prediction markets. Currently, it projects a 59.3% probability that the FOMC will raise interest rates, a 40.7% probability that rates will remain unchanged, and 0% probability of a rate cut.

Even the bond market is showing extreme swings. Bond investors are particularly unnerved during this period of rising central bank rates. Global bond market interest rates continue to rise, driving bond prices down (bond prices move in the opposite direction of interest rates). A September 1 Wall Street Journal article titled "Bond Yields Around the World Soar in Challenge to Government Borrowing" stated:

"The global economy has a new challenge to surmount: an unruly bond market that is sending borrowing costs to their highest levels in decades.

A rout in bond markets deepened Tuesday when Japan's 10-year bond yield touched 3% for the first time since 1996. Markets in other heavily indebted nations had their own superlatives. The U.K's 30-year bond yield hit the highest level since 1998. Bond yields in Germany and France rose to their highest levels in more than a decade. The 10-year U.S. Treasury yield climbed closer to 4.8%, a level last touched in January 2025.

The runup in interest rates has profound consequences for the global economy, heaping pressure on everyone from home buyers to credit-card holders and especially governments, which have borrowed heavily in recent years."

10-Year Government Bond Yields Hit Multi-Decade Highs in 2026: US, UK, Japan, France

Investors are at their wits' end trying to predict what the Fed will do. Most important is how its decision will affect the bond and stock markets. Some view a rate increase as good news because it would suggest the U.S. economy remains strong enough to withstand higher borrowing costs. From this perspective, inflation reflects solid consumer demand that gives businesses the ability to raise prices.

Mark Hackett, chief market strategist at Nationwide, summarized the dilemma on CNBC:

"If you have a CPI [Consumer Price Index] reading that surprises to the upside, that's going to really make it difficult for them [the FOMC] not to hike rates."

The primary reason the FOMC is leaning toward raising rates is that inflation remains well above its 2% target. According to the Bureau of Labor Statistics, the July Consumer Price Index increased 3.4% year over year, slightly below June's 3.5% increase. May's 4.2% increase was the highest since 2023 and was heavily influenced by energy prices. In July, gasoline prices rose 24.6% from a year earlier, while fuel-oil prices increased 39.1%.

US Inflation Rate Eases to 3.4% in July 2026 as CPI Falls From May Peak

Some investors may view rising prices as positive for stocks because higher selling prices can lead to increased profits provided a company's labor and operating costs do not rise even faster. The oil industry is a prime example. Strong worldwide demand and oil prices near multidecade highs have helped many energy companies generate record profits.

The chart below compares the one-year returns of several major oil-company stocks with movements in Brent crude oil prices, represented by the orange line. As the chart illustrates, the companies' stock prices have generally risen and fallen alongside the price of crude oil.

Energy Stock Returns vs Brent Crude Oil Price: ExxonMobil, Chevron, Shell, Halliburton

On the other side of the debate, some investors worry that if the FOMC raises interest rates next week, higher borrowing costs will slow economic growth and weaken corporate earnings. The already fragile housing market could be particularly vulnerable. As the industry enters its traditionally slower fourth quarter, higher mortgage rates would further reduce affordability, price more potential buyers out of the market, and prolong the housing contraction.

This divided investment environment was captured well by Alan Blinder in the August 25 edition of The Wall Street Journal. Mr. Blinder is a professor of economics and public affairs at Princeton University and served as vice chairman of the Federal Reserve from 1994 to 1996. He wrote:

"The case for raising rates would be clear if inflation were creeping up, the economy was steaming ahead with growth at or above trend, and unemployment was below its so-called natural rate. But that isn't the state of the U.S. economy today.

Alternately, there would be a clear case for holding interest rates constant if inflation were declining, economic growth were slowing, unemployment were at or above its natural rate, and the real fed-funds rate were close to 'neutral', perhaps 1.5% or so. But that's not where we are either.

Neither 'clear case' applies. We have, instead, muddy waters. Which option any particular FOMC member prefers depends on how he weighs the various factors, the so-called reaction functions. What the committee does will depend on all that plus how the chairman manages disagreements."

Mr. Blinder's observations explain why investors remain so divided. The economic data does not provide the FOMC or the markets with a clear direction. That uncertainty has contributed to the U.S. stock market remaining stuck in a relatively flat trading range since June 2.

S&P 500 Stuck in Flat Trading Range Ahead of September 2026 Fed Rate Decision

What does this mean to me?

The U.S. stock market's flat trading range reflects the competing economic forces investors are weighing as they consider the outlook for the economy and corporate profits. Their immediate concern is that higher borrowing costs could slow economic growth and weaken corporate earnings.

Our greater concern, however, would be an economic environment that prompts the FOMC to lower interest rates. The Federal Reserve generally cuts rates as a defensive strategy when it believes the economy is weakening and recession risks are rising (e.g. 2000, 2008, 2020). Therefore, a rate cut is when investors should be especially alert to risks in the economy and is not always the good news investors assume it to be.

A particularly serious threat would be deflation, not merely disinflation. Disinflation means prices are still rising, but at a slower rate. Deflation occurs when prices begin to fall broadly across the economy. It can create a difficult cycle in which slowing sales force companies to reduce prices, cut expenses, and lay off employees. Rising unemployment then reduces consumer spending, leading to further declines in sales, prices, and employment. Once underway, this deflationary cycle can be much harder to stop than today's inflationary pressures.

We maintain our favorable view on the US economy and stock market. This period of flat trading in the stock market can create new buying opportunities as corporations grow their earnings and free cash flow while valuations become more attractive. We are monitoring the markets for a breakout from this flat trading cycle. In our opinion, the eventual break appears more likely to be to the upside as investors weigh nearly 100 days of stagnant stock prices against rising corporate values, though no outcome is assured.

Let us know your thoughts on this UPdate. We welcome the opportunity to discuss your views on the investment marketplace and, more importantly, how you are progressing toward financial freedom. If you do not have a comprehensive financial plan with key parameters to achieve financial independence, call us now. We welcome the opportunity to assist you and your family in achieving your goals.

Up Capital Management is an SEC-registered investment adviser. Registration does not imply a certain level of skill or training. The views expressed are those of Up Capital Management as of the date of publication and are subject to change without notice. This commentary is for informational purposes only and is not individualized investment, tax, or legal advice, and no reader should act on this material without consulting their adviser. References to specific securities, including Halliburton, ExxonMobil, Chevron, and Shell, are for illustration only and are not recommendations to buy or sell. Indexes such as the S&P 500 are unmanaged and cannot be invested in directly. Forward-looking statements, including any views on the direction of markets or interest rates, involve risk and uncertainty, and actual outcomes may differ materially. Past performance is not indicative of future results. Data from third-party sources including the Bureau of Labor Statistics, CME Group, YCharts, Trading Economics, and The Wall Street Journal is believed reliable but is not guaranteed for accuracy or completeness.

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