MONTHLY MARKET MUSINGS

October 2026

Rates move higher but equities remain resilient

In September, as expected, the U.S. Federal Reserve (Fed) delivered its first 25-basis-point rate hike in more than three years. With the move already largely anticipated by markets, attention has quickly shifted to whether another increase will happen at the Fed’s October meeting.

While the outlook for October remains uncertain, the market expectations have pointed toward another 25-basis-point increase, and many economists and Fed officials view an additional hike before year-end as the appropriate course of action.[1] However, recent softer-than-expected inflation data has slightly reduced the immediate pressure for the Fed to act in October.[2] The latest Fed projections still suggest that policy rates could finish the year above the current 3.75%–4.00% range, leaving the door open to another increase even if the timing remains uncertain. Following this potential second interest rate hike, the consensus expectation is for an extended pause.[3] Longer term, the Fed projects that inflation will eventually make its way back to their 2% target by 2029.[4]

Historically, the period following the final Fed rate hike has been constructive for equities when the economy remains healthy and inflation begins to moderate. Looking back at the final hikes in 1995, 2006 and 2018, the S&P 500 Index gained approximately 32.1%, 18.3% and 27.3%, respectively, over the 12 months that followed. One notable less-favourable outcome was 2000, when the final hike occurred as the dotcom bubble began to unwind. The takeaway is that equity markets have often generated positive returns in the year after a Fed pause, but a pause does not, in itself, determine the market's direction. What tends to matter more is the reason why the Fed is pausing and what is happening to economic growth and corporate earnings.[5]

Over the past month, it is relatively safe to say that the equity markets absorbed the higher-rate environment quite well. While this was partly due to much of the hike being priced-in, it was also in part due to stocks being supported by resilient economic activity and, most importantly, corporate earnings. This is an important shift from the concerns that dominated markets in August. The rate hike has now moved from a potential risk to a reality, and investors are increasingly assessing whether the economy and corporate sector can continue to perform while monetary policy remains restrictive. The latest earnings season has provided some encouraging evidence. In the U.S., 88.2% of S&P 500 companies reporting results beat consensus earnings estimates, while 81.9% reported positive earnings growth. Canadian equities also posted solid results, although they lagged the U.S., with approximately 55.4% of S&P/TSX Composite companies beating earnings expectations and 76.85% reporting positive earnings growth. The strength of earnings is particularly important because it provides an offset to the pressure created by higher interest rates. When rates rise, investors generally place a lower value on a company's future cash flows. However, if a company continues to grow earnings and maintains healthy margins, they can partially offset that valuation pressure through stronger fundamentals. This gives some context as to why equity markets have remained resilient even as bond yields have stayed elevated.

Technology and AI-related companies remain at the core of the earnings story. The continued investment in semiconductors, data centres, cloud/AI infrastructure and AI capabilities is supporting the significant capital-spending cycle. While this has benefited the largest tech firms as well as many other AI infrastructure companies involved in supporting the adoption, expectations are very high and investors will increasingly look for those investments to translate into consistent revenue gains, productivity improvements and earnings growth.

Heading into the final quarter, we can expect a more balanced market backdrop. Higher rates remain a headwind, but strong earnings and economic activity can offset some of that pressure. The risk is that inflation remains persistent enough to keep rates elevated while economic growth and corporate earnings begin to slow. In that scenario, pressure on equity prices would come from both sides in the form of higher discount rates and weaker earnings expectations. This is why the bond market will also remain an important indicator. While the Fed controls short-term policy rates, longer-term Treasury yields are influenced by inflation expectations, economic growth and the amount of debt being issued. A sustained rise in long-term yields could cause additional pressure on equity valuations even if the Fed were to institute a pause. Equally, a moderation in yields combined with continued earnings growth would create a more favourable environment for equities.

Employment data will be closely watched in October as the Fed looks to balance inflation that is above its target against signs that the labour market may be losing momentum. Robust employment and persistent inflation could increase the need for another rate increase, while softer economic data could give the Fed more reason to pause. The U.S. consumer has also remained an important source of support for equities, with employment and household spending holding up reasonably well. The key question is whether this resilience can persist if borrowing costs remain elevated and the effects of tighter financial conditions become more pronounced.

Looking beyond October, the discussion will gradually shift from how high rates are likely to go to the length of time they are likely to stay at those higher levels. If inflation continues to moderate while economic growth and corporate earnings remain healthy, markets should be better positioned to absorb an extended period of restrictive monetary policy. For now, the recent earnings season has provided investors with a reason for optimism. Companies continue to generate strong earnings, consumers continue to spend and equity markets have shown significant resilience. Heading into the final quarter of the year, the question will be whether the earnings and economic strength we have seen can continue to outweigh the pressure created by an elevated 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

[1] https://www.reuters.com/business/fed-forecasts-see-latest-hike-followed-by-another-before-end-year-2026-09-16/

[2] https://www.cnbc.com/2026/09/30/feds-preferred-gauge-showed-core-inflation-at-3point0percent-in-august-much-lighter-than-expected.html

[3] J.P. Morgan Explains Why Fed Will Stop Hiking Before 2027 After One More December Hike

[4] https://www.nytimes.com/2026/09/30/business/pce-inflation-fed-interest-rates.html

[5] https://advisorservices.schwab.com/node/107066