The headline last week was the Federal Reserve (Fed) decision to raise the federal funds target range by 0.25 percentage points to 3.75% to 4.00%, which also lifted the discount rate to 4.00%.
Markets had widely anticipated a Federal Reserve rate increase due to consistent statements by Federal Reserve Chair Kevin Warsh regarding the concern about rising costs and inflation. This was the first rate increase since former Chair Jerome Powell and the Federal Open Market Committee (FOMC) completed their aggressive rate hike campaign in July 2023 to slow the highest inflation in about four decades. As of today, fed funds futures tracked by CME FedWatch and the Fed's own projections pointed to at least one additional rate increase in 2026.
The FOMC operates under two principal economic mandates when establishing monetary policy:
1. Stable prices, with a target annual inflation rate of 2.0% 2. Maximum employment, although there is no fixed unemployment rate or labor force participation rate target.
Balancing these mandates can be challenging, particularly when inflation remains elevated while economic or employment growth begins to weaken. The Federal Reserve influences financial conditions primarily through its target range for the federal funds rate, interest paid on bank reserves, discount-window lending and management of its securities portfolio.
Higher rates generally increase borrowing costs, discourage some new lending and investment, and can gradually slow economic activity and inflation. Conversely, lower rates reduce borrowing costs, encourage lending and investment, and may stimulate economic growth. In simple terms, the Fed is attempting to regulate the economy using the equivalent of a vehicle's brake and gas pedal without a steering wheel. It can influence the economy's speed, but it cannot precisely control its direction or how quickly businesses and consumers respond.
The United States has experienced several periods of extreme inflation volatility during the past 80 years. Following World War II, year-over-year inflation briefly approached 20% as wartime price controls ended and consumer demand overwhelmed available supplies. Inflation surged again during the late 1970s and early 1980s, eventually exceeding 14%.
In 1979, Federal Reserve Chair Paul Volcker responded with an exceptionally aggressive tightening campaign. The federal discount rate reached 14%, while the bank prime lending rate peaked at 21.5% in December 1980. Although these policies contributed to back-to-back recessions, they ultimately broke the inflationary cycle that had plagued the economy for more than a decade.
The chart below illustrates the year-over-year changes in the Consumer Price Index since 1948, with shaded areas indicating recession periods.
Since the turbulent inflationary period of the late 1970s and early 1980s, both inflation and Federal Reserve interest rates have generally remained within a narrower range. The following chart presents the roughly 75-year history of the Federal Reserve discount rate and the effective federal funds rate, with shaded areas indicating recessions.
Interest-rate changes can also have a significant effect on the bond market. Existing fixed-rate bond prices generally decline when market interest rates rise because newly issued bonds offer more competitive yields. Conversely, existing bond prices generally rise when market rates decline.
A small change in yield can produce a much larger percentage change in a bond's price. For example, if the market yield on a typical 10-year bond increases by 0.25 percentage points, the bond's market value could decline by approximately 2%. A comparable decline in the 10-year yield could produce a similar increase in value. Historically, bond prices have tended to benefit during periods of stable or declining rates.
It is important to distinguish, however, between a Federal Reserve rate increase and a change in the 10-year Treasury yield. The Federal Reserve directly influences short-term interest rates, while longer-term yields are determined by market expectations concerning future inflation, economic growth and monetary policy. Consequently, a 0.25 percentage point increase in the federal funds rate does not necessarily produce an equivalent increase in 10-year bond yields.
The chart below compares the price of the iShares 7–10 Year Treasury Bond exchange-traded fund (ETF) (shown by the orange line) with the yield on the 10-year U.S. Treasury note (shown by the purple line). The chart illustrates the inverse relationship between bond yields and bond prices: when market interest rates decline, existing bond prices generally rise, and when rates increase, bond prices generally fall.
During much of the past quarter century, the bond market has benefited from a long-term decline in interest rates. That trend was reinforced by three major economic disruptions: the bursting of the dot-com bubble, the housing collapse and Great Recession of 2008, and the worldwide economic shutdown caused by COVID-19. In each instance, the Federal Reserve responded by lowering short-term interest rates and providing liquidity to help stabilize the financial system and support economic recovery.
Between these crises, the Federal Reserve periodically raised rates as economic conditions improved. These increases were intended to gradually normalize monetary policy, prevent the economy from overheating and give the Fed greater flexibility to reduce rates during a future downturn.
For example, as the economy continued recovering from the Great Recession, Federal Reserve Chair Janet Yellen led the Fed's first rate increase in nearly a decade in December 2015, while several major central banks were still cutting rates, some below 0%. Jerome Powell continued that gradual tightening policy after becoming Fed Chair in 2018. Those earlier increases provided the Federal Reserve with room to reduce rates when the COVID-19 pandemic abruptly threatened the global economy in 2020.
The return to near-zero interest rates, combined with extraordinary fiscal and monetary stimulus, helped produce a powerful economic recovery. Mortgage rates fell below 3%, housing activity surged, and historically low borrowing costs encouraged consumers and businesses to borrow and invest.
However, the combination of strong demand, supply-chain disruptions, labor shortages and massive government stimulus also contributed to the highest inflation in approximately four decades. In March 2022, Powell and the FOMC reversed course and began one of the most aggressive interest-rate campaigns since the early 1980s.
The year 2022 was a historically difficult one for the bond market as the FOMC raised rates, and volatility continued into 2023. Those rate increases reversed much of the earlier appreciation in bond prices. As newly issued bonds began offering substantially higher yields, older bonds paying lower interest rates became less attractive and declined in market value.
What does this mean for me?
The purpose of reviewing Federal Reserve history is to better understand the relationship between interest rates and bond prices. Based on recent comments from Federal Reserve Chair Kevin Warsh and other Federal Reserve officials, the FOMC appears relatively comfortable with current labor-market conditions. Its principal concern remains inflation, which continues to exceed the Fed's 2% long-term target. Therefore, one or more additional rate increases may be possible if inflationary pressures persist.
Changes in monetary policy do not affect the economy immediately. Although estimates vary, it can take several months for higher interest rates to fully influence borrowing, consumer spending, business investment, employment and inflation. The FOMC will therefore monitor the effects of last week's increase before deciding whether further action is appropriate at its remaining 2026 meetings on October 27–28 and December 8–9.
For the foreseeable future, the possibility of additional rate increases could continue to pressure bond prices. However, the Federal Reserve's objective is not deflation, which is an outright decline in the general price level. Its goal is disinflation, a gradual reduction in the inflation rate toward its 2% target, while maintaining economic and labor-market stability. Investors refer to achieving this delicate balance as a "soft landing" or the Goldilocks scenario of an economy not too hot or too cold.
That said, the only predictable feature of the economy is that it remains unpredictable. History suggests that another recession will eventually occur, although no one can reliably forecast its timing. When economic growth and employment begin to deteriorate, the Federal Reserve has historically responded by lowering interest rates to stimulate new lending and economic activity.
If that occurs, bond prices could benefit as market yields decline. In past downturns, bonds have often provided income and diversification when stocks declined, although that relationship does not always hold.
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Important Disclosures Up Capital Management is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training. The opinions expressed are as of September 22, 2026 and are subject to change without notice. This commentary is for informational purposes only and is not individualized investment, tax or legal advice. Statements about future interest rates, inflation, economic conditions and bond prices are forward-looking, involve risks and uncertainties, and actual results may differ materially. The iShares 7–10 Year Treasury Bond ETF is shown for illustration only and is not a recommendation to buy or sell any security, and its price chart excludes reinvested income. As of the publication date, some Up Capital Management clients hold the iShares 7–10 Year Treasury Bond ETF (IEF), and Up Capital Management may buy or sell this security for client accounts at any time without notice. The Consumer Price Index is an economic measure and cannot be invested in directly. Past performance is not indicative of future results. Bond prices generally fall when interest rates rise, and all investments involve risk, including loss of principal. Data from YCharts, the Federal Reserve Board, the International Monetary Fund and FRED is believed reliable but is not guaranteed.