As Fed officials remain in a wait-and-see mode, active bond managers are pursuing opportunities in today’s challenging backdrop.
Key Takeaways
The Fed remains on hold, a position we believe may continue if inflation and real yields don’t deviate much from current levels.
Fed Board Chair Kevin Warsh provided no forecast in the central bank’s monetary policy statement, saying rate forecasting isn’t prudent in these uncertain times.
While the macro environment has led to a complex bond market backdrop, our active management continues to uncover opportunities among corporate bonds.
What Was the Fed’s Interest Rate Decision in July 2026?
Decision: As we expected, the Federal Reserve (Fed) left interest rates unchanged at its fifth straight monetary policy meeting.
Target Range: 3.5% to 3.75%
Vote: Three members of the 12-member Federal Open Market Committee (FOMC) dissented, preferring a rate hike over holding steady. This was the first time since 2016 that three Fed officials dissented in the same direction over a rate change.
Figure 1 | Target Rate Unchanged, But Hikes Implied in Futures Prices
Why Did the Fed Leave Rates Unchanged?
Despite still-elevated inflation and uncertainty from the Iran conflict, policymakers continued to favor patience in their approach to interest rate policy. An economy that’s remained resilient despite recent oil market shocks and a healthy labor market has enabled the Fed’s wait-and-see approach.
Warsh cited two key developments as contributors to the Fed’s decision:
Higher yields. Since the June Fed meeting, nominal and real yields have moved materially higher across the yield curve. Warsh noted the reduction in Fed forward guidance may have been a factor. But he also insisted that when markets respond to real data and economic developments, it’s “a change for the better.”
Growth in business investment. Warsh said a surge in capital spending is helping sustain the healthy momentum in manufacturing output and setting the stage for future growth. He also cautioned that the timing and magnitude of the effects remain difficult to predict.
Is a Near-Term Fed Rate Hike Inevitable?
In our view, Warsh is less focused on any single inflation metric. Instead, he appears more focused on whether inflation expectations remain anchored, real yields remain restrictive and overall financial conditions continue to tighten.
We believe the key issue for the Fed is how patient it should be with an above-target inflation rate. The Fed chair appears focused on whether interest rate policy and market-imposed financial conditions are restrictive enough to return inflation to its 2% target.
Given this perspective, we believe the Fed will likely stay on hold at its next policy meeting in September. This outlook hinges on the monthly core inflation rate remaining near 0.2% and real yield levels that continue to promote restrictive financial conditions.
The biggest risk to our outlook includes a combination of factors that may force the Fed into raising rates:
Monthly core inflation increasing 0.3% or higher
Rising inflation expectations
Falling real yields
How the Fed Can Maintain Credibility on Inflation
In his post-policy-meeting press conference, Warsh demonstrated that he’s not a traditional hawk. Rather than relying primarily on additional rate hikes, he appears focused on preserving the credibility of the Fed’s 2% inflation target. When a reporter suggested that five years of high inflation indicates the Fed’s target is actually higher than 2%, Warsh insisted it remains 2%.
Nevertheless, the bond market is waffling on Warsh’s credibility, given his reliance on inflation expectations, real yields and financial conditions.
How Are We Attempting to Gauge Fed Policy?
With the Warsh-led Fed eliminating forward guidance, assessing a mix of data is even more important. We are focusing primarily on:
Longer-term trends in core inflation, rather than any single monthly inflation reading
Evidence that inflation pressures are broadening beyond isolated supply shocks
Underlying pricing trends, absent unusually large monthly moves triggered by oil shocks, weather, etc.
Market-based inflation expectations, including inflation break-even rates
10-year real yields
Broad financial conditions
If these measures continue to improve while real yields remain elevated, we believe the Fed can remain on hold. If inflation remains sticky, expectations rise or real yields decline materially, the probability of a September hike increases significantly.
How Have Inflation and Interest Rates Affected Corporate Bonds?
Inflation’s impact on corporate bonds has largely been issuer-specific. For example, higher energy costs have boosted trucking and freight costs for some companies and input costs for others. But inflation may have a more modest effect on companies with solid pricing power, such as select consumer staples and other essential services firms.
However, our overall goal is to seek companies on the verge of experiencing positive events or catalysts.
Meanwhile, in today’s higher interest rate environment, we believe bond yields remain broadly attractive. Banks, in particular, have been big beneficiaries of higher interest rates and increased corporate deal activity, including mergers and acquisitions (M&A) and buyouts.
Additionally, we believe certain higher-quality high-yield bonds may offer compelling total return potential. We’re also finding opportunities among rising stars — former high-yield bonds whose credit-quality upgrades moved them into the investment-grade universe.
Higher interest rates have had the greatest impact on companies with low credit-quality ratings. Among these borrowers, free cash flow is thinner and more sensitive to financing costs.
How Does Reduced Fed Forward Guidance Affect the Bond Market?
The lack of forward guidance has contributed to higher interest rate volatility, which typically results in greater uncertainty and wider credit spreads. In our view, this is an environment well-suited for active bond managers.
Warsh’s recent comments suggested the Treasury market is doing the heavy lifting for the Fed. That is, yields have risen without explicit Fed action, resulting in a steeper yield curve where longer-maturity yields are rising faster than shorter-maturity yields.
This dynamic supports our preference for owning shorter-maturity, higher-yielding corporate bonds, without going too far out on the maturity spectrum. For example, we generally prefer underweight exposure to corporate credit with maturities of more than 10 years.
We believe this maturity focus supports our primary investment approach: searching for catalyst-driven corporate opportunities with positive event risk. While we hunt for opportunities across the maturity curve, owning longer-maturity securities comes with greater risk in today’s market.
Specifically, we believe owning maturities without a positive catalyst for spreads to tighten and prices to increase is a risk not worth taking, given their greater interest-rate sensitivity.