US Fed hike reinforces the case for dynamic duration management

The unexpected Federal Reserve rate hike and rapid repricing of bond markets support dynamic rather than static duration management.

• The Fed raised rates by 25 basis points to a 3.88% midpoint, reversing its late-2025 cut after inflation data surprised to the upside following Kevin Warsh’s 28 August Jackson Hole speech.
• Since the day before that speech, two-year Treasury yields rose 50bps, while German and UK two-year yields increased 36bps and 39bps respectively; the 30-year Treasury yield rose only 17bps, producing generally flatter curves.
• Equities and credit spreads remained resilient, but total returns across fixed-income asset classes fell, while volatility increased in the AI sector amid funding uncertainty.
• L&G believes inflation remains structurally sticky because of loose fiscal policy, deglobalisation and energy-security concerns, but considers short-term rate forecasts unreliable and had judged consensus expectations of no further Fed hikes in 2026 and curve steepening to be overconfident.
• Its unconstrained bond portfolios retain constructive credit exposure, targeting short-end carry in subordinated European banks, subordinated US utilities, emerging markets, hyperscaler debt and business development companies, while weighing credit, liquidity, market and issuer risks.

Takeaway: Investors should reduce or reshape duration when inflation keeps yields rising, but add duration if bond-market volatility begins to damage growth expectations; L&G will monitor inflation, wages, energy prices and credit-market volatility.