On September 16, the Federal Reserve raised its policy rate for the first time since July 2023, lifting the federal funds range by a quarter point to 3.75%–4.00%. The vote was unanimous. Chairman Warsh was blunt about the reason: inflation has been too high for too long, and this summer's readings did not convince the Committee that the underlying trend had improved.

Markets had already been leaning that way. On the day of the decision, the 10-year Treasury yield held near 5%, its highest level since 2023, the 2-year rose to about 4.74%, and the dollar index closed above 100. Stocks slipped, with the Dow down more than 1%.

If you read the headlines, this looks like the moment to get defensive. Our investment process says something more specific, and I want to walk through what it says and why. The difference between "a hike happened" and "a hike happened that changes the regime" is the whole job.

What the decision means for the market

A rate hike does three things at once. It raises the cost of borrowing across the economy, from mortgages to corporate credit. It makes cash and short-term bonds more attractive relative to stocks. And, when other central banks are not moving in step, it tends to strengthen the dollar, which tightens financial conditions around the world.

What matters for investors is not the hike itself but what comes next. The Fed's own projections show one more increase this year, not a campaign of them, and rates holding roughly steady through 2027. That is a meaningful difference. A single adjustment in a strong nominal economy is something markets can absorb. A sustained tightening cycle is a different environment altogether. For now, the evidence points to the first, and our portfolios are positioned accordingly.

Liquidity first, headlines second

Sovereign's macro overlay starts from a simple premise: over any horizon that matters to a portfolio, asset prices follow the amount of money and credit available to buy them. We track that directly — global liquidity growth, its momentum over the last three months, the funding conditions that support it, and the handful of variables that have historically broken it: a surging dollar, a disorderly bond market, credit stress.

For most of this year, the dominant fact has been that the liquidity supporting markets is being generated by the Treasury, through short-term bill issuance and bond buybacks, rather than by the central bank. That is why risk assets rallied while the Fed sat still, and it is why a single rate hike is not, by itself, a reason to change course. The engine that matters is still running; our liquidity readings show it growing, slowly. What the decision does is raise the cost of running it, and our model has a specific place to put that information.

The midterm-year pattern

There is a second reason we came into this meeting with a hedge already in place, and it has nothing to do with the Fed. Historically, the second year of the four-year presidential cycle — the midterm year — has been the weakest of the four for U.S. stocks. Since 1950, the S&P 500 has averaged roughly 5% in midterm years, the lowest of any year in the cycle, and the average peak-to-trough decline in a midterm year since 1961 has been 19%.¹ A more recent sample tells the same story: across the fourteen midterm years from 1970 to 2022, the index averaged 7.5% against 12.4% for all years, and the last two midterms — 2022 at −18.1% and 2018 at −4.4% — were the two worst years for the index since 2008.² The reasons are structural rather than partisan: policy uncertainty peaks before the vote, fiscal support tends to be back-loaded toward the following year, and the Fed has often been tightening into the middle of the cycle, as it is now.

The same history carries a second lesson that is easy to forget in September: the weakness has typically resolved into one of the strongest stretches of the cycle. The year following a midterm has averaged about 14%, the best of the four, and the index has been higher twelve months after the midterm election 95% of the time since 1938.¹

The pattern argues for a hedge, not a retreat: expect a rough patch, keep something in reserve for it, and be positioned to add rather than be forced out.

That is exactly how our growth strategy is set up today.

Decisions written before the meeting, not after

Rather than asking "how do we feel about the Fed?" on the afternoon of the decision, our process writes the decision down ahead of time. Before the September meeting we had three branches on paper, each tied to a portfolio action.

September 16 printed the middle branch. The projections show one more hike this year, not a campaign. The Chairman was hawkish in tone but did not commit to a path. Under the rules we set before the meeting, that is not a downturn call. The growth strategy stays invested, the hedge stays on, and nothing else moves.

What tightened, and what didn't

Underneath the event branches sits a standing set of guardrails that we check after every close — levels on the variables that have historically preceded a liquidity downturn, each mapped to a pre-assigned action for every strategy we run. Two of them moved closer to their lines around the decision without crossing, and I would rather say that plainly than pretend the picture is unchanged.

What this means for our two strategies

The point of all this

Most investors experience a rate hike as an emotion. We built our process so that it arrives as a data point with a pre-assigned meaning. That does not make us right about the market — no framework does — but it means our decisions are made in advance, on the evidence, rather than in the afternoon, on the tape. On September 16 the framework said: this is a hike in a midterm year, not a regime change. Note what tightened, hold the line, keep the hedge, and be ready to add into the weakness history says is likely.

If one of our guardrails is crossed, you will hear from us with the same clarity about what we did and why.