September: Higher Rates Put the 60/40 Portfolio to the Test

September marks an important shift in market perceptions. While concerns over the summer focused primarily on the risk of a sharp economic slowdown, resilient growth has shifted the focus back toward inflation and the path of interest rates. Equities and bonds have therefore declined in tandem since the beginning of the month, once again testing the traditional diversification benefits of the 60/40 portfolio.

In the United States, however, the data continue to support our soft-landing scenario. The rebound in job creation in August has eased concerns following July’s weakness, while services remain firmly in expansion territory and manufacturing activity continues to improve. The issue is therefore no longer really growth, but rather the insufficient pace of disinflation. CPI rose 0.4% in August, following 0.1% in July, while core inflation increased by 0.3%, slightly above expectations. More concerningly, part of the upside surprise came from non-housing core services, suggesting that inflationary pressures are not confined to the energy shock.

The repricing of monetary policy expectations has been swift. In the space of one week, the implied probability of a 25-basis-point Fed hike in September rose from around 60% to almost 90%. The question for markets is therefore no longer so much whether the Fed will raise rates this week, but how much further it may need to go thereafter. Against this backdrop, the Fed’s updated economic projections and its communication will be at least as important as the rate decision itself.

In Europe, the picture is broadly similar. Eurozone GDP expanded by 0.6% in the second quarter, while the manufacturing PMI, at 52.7, confirms the gradual improvement in industrial activity. But the rebound in inflation, from 2.9% to 3.3% year-on-year, has already prompted the ECB to raise rates by 25 basis points. On both sides of the Atlantic, resilient growth is giving central banks greater latitude to address inflation that is proving more persistent than expected.

Most importantly, the energy shock is occurring at the worst possible time. Brent crude has risen from around USD 84 in early August to more than USD 105 per barrel, an increase of almost 30% in six weeks. The surge primarily reflects supply disruptions in the Middle East and tensions along key export routes, rather than stronger global demand. It is therefore essentially an inflationary supply shock which, while not yet challenging our soft-landing scenario, significantly reduces central banks’ room for manoeuvre. With disinflation already showing signs of losing momentum, oil remaining sustainably above USD 100 increases the risk that price pressures persist and interest rates remain higher for longer.

It is precisely this combination that is putting the 60/40 portfolio to the test. A conventional recession would normally lead to lower interest rates, allowing bonds to offset weakness in equities. September presents the opposite configuration: resilient growth, persistent inflation and an oil shock pushing bond yields higher. As a result, equities and bonds are simultaneously under pressure. In the short term, the main risk for portfolios is therefore less a recession than a more pronounced “higher for longer” environment than markets had anticipated. Over the longer term, however, there is a more constructive side to this adjustment: higher bond yields are gradually rebuilding carry and the diversification potential of high-quality fixed income.

United States: When Debt Meets 5% Interest Rates

Persistently higher interest rates are no longer just a valuation issue. In the United States, they are increasingly interacting with another vulnerability: a fiscal trajectory that is becoming more difficult to absorb. The 10-year Treasury yield is now approaching 5%, while the 30-year recently reached 5.35%, just as federal debt has surpassed USD 40 trillion. At the same time, the deficit is expected to reach 5.8% of GDP in 2026 and remain above 5.5% throughout the coming decade, an unusually large fiscal shortfall for an economy operating close to full employment.

The immediate issue is less the stock of debt than the cost of refinancing it. As securities issued during the zero-rate era mature, they must be refinanced at significantly higher yields. Net interest expense already stands at around USD 1 trillion per year, or 3.3% of GDP, and is projected to exceed USD 2.1 trillion by 2036. Interest payments already absorb close to one-fifth of federal revenues and, over the first eleven months of fiscal year 2026, increased by a further 13%, or USD 143 billion.

The risk is a self-reinforcing deficit–issuance–rates loop. Structural deficits of close to 6% of GDP require an ever-growing supply of Treasuries; greater supply, combined with persistent inflation, may require investors to demand a higher term premium; higher yields then increase debt-servicing costs and feed future deficits. The Treasury’s recent decision to triple the size of a long-dated bond buyback operation to USD 6 billion—without preventing yields from moving higher—illustrates the growing sensitivity of the market.

This is where the policy equation becomes particularly uncomfortable. Resilient growth, persistent inflation and now higher oil prices all argue for higher interest rates, while the US fiscal trajectory increasingly requires the opposite. The question is therefore not whether the United States can nominally service its debt, but at what yield investors will be willing to absorb an ever-growing supply of Treasuries. And the higher that clearing yield moves, the greater the political pressure to bring interest rates back down.

Fed, Midterms and Fiscal Dominance: Gold as a Hedge Against a Policy Mistake

With the November midterms only weeks away, this economic tension is becoming increasingly political. The Fed is increasingly caught between market and political pressures: resilient growth, sticky inflation and oil above USD 100 argue for higher rates, while the Trump administration is pushing for the opposite. This divergence represents a growing risk. High mortgage rates and tight financial conditions are increasingly difficult to accommodate ahead of an election, while long-term yields close to 5% are rapidly increasing the government’s debt-servicing burden. Political pressure for easier monetary policy is therefore building precisely when economic fundamentals call for greater caution from the Fed.

The risk is that keeping policy too accommodative relative to the inflation outlook could prove counterproductive, pushing inflation expectations and long-term yields higher. Any perceived erosion of Fed independence could unsettle inflation expectations and lead investors to demand a higher term premium. Short-term rates might remain anchored or decline, while long-term yields remain elevated or move even higher. Influencing the Fed, in other words, does not necessarily mean controlling the government’s cost of funding.

The real tail risk would be a gradual shift toward fiscal dominance, whereby monetary policy becomes increasingly constrained by the government’s financing needs. In an extreme scenario, this could eventually lead to some form of financial repression or even Yield Curve Control, with the central bank using its balance sheet to contain long-term yields at levels deemed compatible with fiscal sustainability. This is not our base case. But with federal debt above USD 40 trillion, deficits close to 6% of GDP and long-term yields around 5%, the risk looks less theoretical today than it did only recently.

It is against this backdrop that we have recently increased our exposure to gold within our portfolios. Beyond its traditional role as an inflation hedge, we view gold as protection against the broader risks of fiscal dominance and an erosion of US monetary credibility. Any attempt to contain long-term yields below levels justified by inflation and fiscal fundamentals would likely compress real rates and undermine the US dollar, strengthening the investment case for gold.

Our increased gold allocation is therefore less a directional bet on inflation than a hedge against a potential US policy mistake: fiscal slippage, political interventionism and an erosion of Fed independence.