MONTHLY MARKET MUSINGS

September 2026

The Rate Debate

In August, the market experienced a shift in interest-rate expectations. As we have noted recently, the U.S. and Canada have been increasingly moving in different directions on monetary policy. Stateside, markets have shifted over the course of 2026 from initially expecting further easing from the U.S. Federal Reserve (Fed) to taking a more neutral stance. Now, the market is pricing in a meaningful risk of a potential rate hike as the Iran war persists and inflation remains elevated.

The Canadian picture is somewhat different, as the outlook is much more balanced. The weaker domestic economy has given the Bank of Canada (BoC) less reason to follow the Fed and raise rates further. Following recent comments from U.S. Fed Chair Kevin Warsh at the Jackson Hole meeting, markets quickly increased the probability of a September rate hike to 60.4%, from a significantly lower level before his remarks[1]. The two-year Treasury yield spiked nearly 13 basis points on August 28th, while the U.S. 10-year Treasury yield remained around 4.7%.[2] The shift indicated a market that is increasingly concerned that inflation may be too persistent for the Fed to remain neutral and that monetary policy may need to become more restrictive in the near term before eventually moving lower.

Canada presents a slightly different scenario. The BoC has maintained its policy rate at 2.25%, while the domestic economy continues to show signs of weakness and inflation is expected to move toward the BoC’s 2% target.[3] Earlier in the year, Canadian markets were facing a similar prospect of a potential policy-tightening cycle, but those expectations have since dissipated. That said, Canadian bond yields have still moved higher in response to rising U.S. yields. The question now is less about whether the BoC will follow the Fed and more about how long Canadian yields can remain insulated from rising U.S. rates.

For U.S. equities, this adds an unwelcome layer of uncertainty heading into September. When short-term rates move higher, the discount rate applied to future earnings increases. This typically puts more pressure on longer-duration growth stocks and the technology sector. That sensitivity was evident as the technology sector took a pause despite very strong quarterly results. The key issue is not necessarily that higher rates will trigger an immediate re-pricing of stocks, but rather that there is less room for valuation multiples to expand at a time when expectations for earnings growth are already high. In general, U.S. stocks are more exposed to the risk of a higher-for-longer Fed, due largely to their significant technology exposure and other high-multiple sectors. That said, the current rate-hike probability has likely been factored into U.S. equity prices at this point. Canadian equities, conversely, have a higher weighting toward financials, energy and materials, which can be less sensitive to changes in long-term growth expectations. At the same time, the weaker Canadian economy, tariffs and higher borrowing costs will likely remain headwinds for domestically oriented companies.

The result is a market where rates, rather than growth, have become the key swing factor for equity valuations in the near term. This is likely to perpetuate volatility in stocks as we move into the fall season. Positive U.S. employment and inflation data will help determine whether the recent increase in Fed hike expectations is justified. Strong data may push yields and the U.S. dollar higher, putting additional pressure on equity multiples, while softer data could provide some relief to rate-sensitive sectors and reverse some of the rate repricing experienced in August.

The key takeaway from August is that U.S. equity markets have determined that higher yields are a real possibility. While expectations for earnings growth remain very strong, further increases in real yields could become a greater headwind should we enter a full rate-hiking cycle. Equities appear to remain the best vehicle for returns at this stage, even as the market continues to ebb and flow while pricing in an ever-changing economic landscape and interest rate environment.

JAY SMITH, CIM®, FCSI®
Senior Portfolio Manager & Senior Wealth Advisor 
jay.smith@cibc.ca

BRAD BROWN, MBA, CFA®
Portfolio Manager & Associate Investment Advisor
brad.brown@cibc.com