Weekly Buzz: America is hiring. So what’s next for interest rates?

Traders are reading the tea leaves for clues on whether the US will raise interest rates. Stubborn inflation said yes; a weakening jobs market said no; and the Federal Reserve's new chair, Kevin Warsh, has kept his cards close. With the latest jobs report, the picture has sharpened.

What’s going on here?

The US economy added 162,000 jobs in August, roughly triple the 53,000 that economists expected, and the strongest month of hiring since March. Meanwhile, July's initially reported loss of 23,000 was revised into a gain of 21,000. The big worry about an interest rate hike is that it could slow the economy, but with the jobs market looking sturdier than expected, that worry carries less weight.

This week’s inflation report is the final piece of the puzzle before the Fed makes their decision on rates next week. Inflation hasn't been particularly cooperative. Consumer prices were 3.4% higher in July than a year earlier, and the Fed's preferred gauge – the personal consumption expenditures index – came in at 3.7%. Much of this year's pressure on prices traces back to the oil shock from the US-Iran conflict.

While Warsh has made a point of not signalling the Fed's next move in advance, he has stressed that the Fed remains committed to the 2% inflation target. That puts him at odds with President Trump, who has pushed for lower rates, and it’s made next week an early test of the new chair's independence.

Speaking on Bloomberg this week, our CIO, Stephanie Leung, pointed out that core inflation, which strips out volatile items like food and energy, is tracking at around 2.4%. That’s much closer to the Fed's target and a long way from the 5% to 6% readings of 2022.

She also noted that markets have already responded to Warsh's hawkish tone, pushing borrowing costs higher without the Fed making a move. There's precedent for staying put, too: the Fed has never started a rate hike cycle in the second half of a US midterm election year, which 2026 is.

What’s the takeaway?

An interest rate hike won't hit every part of the economy equally. More rate-sensitive sectors tend to feel it most: real estate, where higher mortgage costs can dampen demand, and capital-heavy industries like utilities, which carry higher levels of debt.

A hike could also add fuel to the recent bond selloff: government bond yields are at their highest since 2008, and a hike could push them up still. Those higher yields could offer investors better returns at relatively lower risk. That said, our CIO added on Bloomberg that oil prices are only part of the picture; a strong US economy and the AI buildout are also driving demand. When growth is what's keeping prices elevated, equities have historically tended to outperform bonds, even when yields are high.

Either way rates go, not everything in a diversified portfolio will react the same way. Within stocks, rate-sensitive sectors can struggle with higher borrowing costs, while others are less affected. Within fixed income, shorter-dated bonds are less exposed to rate moves. On top of that, different regions operate at different points in their own rate cycles.

That's the practical case for diversification. A portfolio spread across different asset classes, regions, and currencies gives you exposure to the parts of the global economy that benefit from a hike, as well as the parts that benefit if rates stay put or get cut.

(If you want an expert-managed portfolio that’s diversified across assets and countries, set to a risk level that you’re comfortable with, check out General Investing.)

Past performance is not an indicator of future returns. These articles were written in collaboration with Finimize.