Fed Outlook 2026: Rising Rates are Back. Is Your Bond Portfolio Ready?

• In September, the U.S. Federal Reserve increased interest rates by 0.25% to a range of 3.75% to 4.0%. The decision to raise rates was primarily based on reducing elevated levels of inflation to deliver price stability. However, the committee noted that economic activity is expanding at a solid pace. The forward path of rates has become less certain, with the current fed funds futures pricing at 4.2% by year end.
• Long-term yields have also risen to almost 20-year highs.¹ During the post-meeting press conference on September 16, Chairman Kevin Warsh noted that higher 10-year Treasury yields have been driven by economic strength, competition for capital and geopolitical factors.
• Given this current backdrop, we see opportunities for investors to put extra cash to work, possibly allocating to floating rate exposures, managing interest rate risk with intermediate maturities, building bond ladders and seeking higher income outside of core bonds.

The outlook for Fed policy has shifted significantly in 2026. Market participants entered the year expecting rate cuts, then in March began pricing in multiple rate hikes by year end.³ In September, the Federal Reserve increased the fed funds target rate by 0.25% to a range of 3.75% to 4.00%. Our baseline scenario is for the Fed to hike one additional time in 2026 as the Fed seeks to reduce inflation at "sufficient speed". While the move is significant, we don’t believe this is the start of an aggressive hiking cycle. The Chairman has emphasized his intention to provide less forward guidance, but a demonstrated commitment to bringing inflation back towards target could help contain inflation expectations and support longer-term bonds. The committee noted that the forward path of rates has become less certain, with fed funds futures currently pricing in 4.20% by year-end.⁴

Beyond 2026, the outlook is more uncertain as:

• The Fed is navigating a shifting geopolitical, technological and economic landscape as it aims to focus on its dual mandate of price stability and full employment. The economy remains resilient, but growth is becoming more uneven. Strong AI investment and consumer spending continue to support the economy, but higher interest rates may continue to weigh on more interest-rate-sensitive parts of the economy, including housing, small businesses, and lower-income consumers.
• Inflation remains above the Fed’s 2% target, and the U.S. labor market strength has been concentrated in certain sectors, such as healthcare, education and hospitality.⁵
• Fed Chair Kevin Warsh launched five new policy task forces, reflecting areas where Chair Warsh is considering the largest changes to existing Fed policy. In press conferences, Warsh reiterated his aversion to forward guidance several times, which we expect to translate to greater rate volatility.

For investors, we believe bonds offer a compelling opportunity set for income generation. Higher Treasury yields may reflect strong economic growth rather than purely inflation pressures. We continue to favor the front end and belly of the yield curve (intermediate maturities under 10 years), where investors can seek attractive income while maintaining flexibility. Floating rate bonds can enable investors to benefit from higher rates as their coupons are reset. Investors can seek income with corporate credit, securitized assets, and emerging market bonds.

At the beginning of 2026, the market was pricing in rate cuts by the Fed but is currently pricing in one additional rate hike this year to bring the overnight rate to a range of 4.00% to 4.25%.⁶ The market is pricing in another one or two hikes in 2027 to bring the fed funds target rate to 4.25% to 4.5%, based on both the Fed's Summary of Economic Projections and their desire to restore price stability (lower inflation rates) to the economy.

The Summary of Economy Projections, known as the Dot Plot, was first released in 2012 to improve transparency. However, Chairman Warsh did not submit an estimate for the June 2026 meeting, his first as Fed Chair, and he mentioned an aversion to forward guidance during the press conference.

The September 2026 Dot Plot demonstrated more officials seeking to keep rates elevated in the near term. According to the Fed’s latest projections, policymakers expect the fed funds rate to gradually decline toward a longer-run level of approximately 3.25%.⁷

In June 2026, Chairman Warsh announced the creation of five Task Forces: Communications, the Balance Sheet, Data Sources, Productivity and Jobs, and the Inflation Framework.

These task forces will gather data and make recommendations before the end of the year. The findings could provide policymakers with additional information as they evaluate future policy decisions. Investors should monitor future announcements for potential signals of how the central bank's approach may evolve.

Since the Global Financial Crisis, the Fed has increased its use of its balance sheet as a monetary policy tool, purchasing U.S. Treasury securities and agency mortgage-backed securities to help influence longer-term interest rates and broader financial conditions alongside changes to the federal funds rate.⁸

By buying bonds, the Fed aimed to lower long-term interest rates, making borrowing cheaper and stimulating economic activity. This process is known as quantitative easing.

Conversely, the Fed can reduce its balance sheet by selling bonds or allowing them to mature without reinvestment. This increases the amount of Treasury and mortgage-backed securities available to private investors, which can put upward pressure on longer-term interest rates and tighten overall financial conditions, a process known as quantitative tightening.

A new task force focused on the balance sheet will evaluate both the size and composition, while considering the need to provide the banking system with ample reserves. No new announcements were made at the June meeting aside from the task force creation. The Fed’s balance sheet is $6.7 trillion or 21% of nominal GDP – but has declined by $2.2 trillion since June 2022. ⁹

In contrast to the Fed, the U.S. Treasury Department increased the size of the U.S. Treasury buyback program. This program’s goal is to improve liquidity and stability in the U.S. Treasury bond market. In August 2026, the U.S. Treasury increased the size of its buyback operations for longer-maturity U.S. Treasuries.¹⁰ This program is expected to continue, providing support for the bond market.

Under this market backdrop, here are some ways investors can use bond ETFs to position their portfolios:

• Put cash to work: If overnight interest rates stay higher for longer, investors could consider allocating to 0-3 month Treasuries or diversified short duration bonds. Investors interested in short-term bonds may consider the iShares 0-3 Month Treasury Bond ETF (SGOV).
• Ride up rate hikes with floating rate: Floating rate bonds have coupons that reset at regular intervals with short-term rates. Investors considering floating rate bonds can select from U.S. Treasuries (TFLO), corporate bonds (FLOT), AAA CLOs (CLOA) and bank loans (USLN).
• Reduce long-end exposure: With the Fed reducing forward guidance, there may be more interest rate volatility. Investors interested in reducing exposure to 10-plus-year bonds, which generally have the most interest rate risk, may consider the iShares 1-10 Year Treasury Bond ETF (GOVM) and iShares 1-10 Year U.S. Aggregate Bond ETF (AGGM).
• Build bond ladders: Bond ladders hold an equal weight to each calendar year and can allow investors to seek consistent income despite changes in interest rates. iShares iBonds 1-5 Year Corporate Ladder (LDRC) offers exposure to a professionally managed corporate bond ladder.
• Seek higher income: Boost fixed income returns with potentially higher yielding bonds, such as high yield, emerging markets, bank loans and collateralized loan obligations (CLOs). Investors interested in higher yielding bonds may consider the iShares Broad USD High Yield Corporate Bond ETF (USHY), the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB), the iShares Flexible Income Active ETF (BINC) and the iShares Securitized Income Active ETF (SECU).