Latest Market Commentary Third Quarter 2026

Under Pressure: The Federal Reserve

What will the Federal Reserve do, and how will its actions affect economic conditions and financial markets? That’s a question on many people’s minds since September 15, when the Fed raised its short-term interest rate target by 25 basis points (0.25%) despite Fed Chair Kevin Warsh’s earlier commitment to President Trump to lower rates. But we should also note Fed policy affecting long-term rates, which the Fed is nudging up. Warsh aims to fight inflation by creating “demand destruction” through rates that make it expensive to buy things. It’s Fed Chair Warsh’s best option because he has no control over inflation driven by rising energy costs and ancillary effects on food and material prices.

For insight into the risks of Fed influence over long-term rates, I read “Liquidity Dependence and the Waxing and Waning of Central Bank Balance Sheets”, co-authored by Raghuram Rajan, former governor of the Reserve Bank of India.¹ Fed Chair Warsh values Rajan’s insights and appointed him as a co-leader of the Fed’s task force to “Examine the costs, benefits, and institutional implications of the Federal Reserve’s current balance sheet regime.”² Essentially, the task force is assessing how the Fed should unwind its balance sheet, which it expanded by nearly $5 trillion in purchases of Treasury bonds and mortgage-backed securities as part of its “quantitative easing response,” a stimulus to the COVID-19 economic crisis.³

Rajan’s appointment suggests that Warsh agrees with the paper’s view that “the expansion and shrinkage of central bank balance sheets has led to liquidity dependence of banks on central banks.”⁴ In other words, the quantitative easing that followed the emergence of the COVID-19 pandemic created easy money that led banks to take too many risks—risks that banks aren’t reducing despite the fact that the Fed is now tightening the availability of credit by allowing longer-term interest rates to rise by reversing quantitative easing. These are the kind of risks that led to the failure of Silicon Valley Bank and other regional banks in 2023.

The yield on the 10-year Treasury hit 5.34%, its highest level since July 2002.⁵ The 87.1 basis point 3^rd quarter move in the 10-year Treasury yield resulted in the worst quarter for bonds in 32 years.  Some might see a “bear steepener,” in which short-term rates rise faster than long-term rates.  But I see it as a parallel shift in the yield curve, where the Fed engineers a parallel shift in yields across the curve as it ratchets rates higher to slow an overheating economy. This scenario could potentially result in a liquidity crunch that makes it hard for companies to meet their financial obligations.

As long-term rates rise, creditors who borrowed during a period of much lower rates (i.e., 2021) may struggle to pay the new, higher rates when they roll over their loans. Investors in these older private loans are likely to suffer. This will further stress the economy, although creditors who borrowed more recently at higher rates went through underwriting to perform at these higher rates and are thus more likely to weather the shift in interest rates.

Across-the-board interest rates are rising worldwide, and countries—especially those like Japan that import all of their oil—are feeling a lot of stress. We are likely to see a global crisis as interest rates rise.

Interest rates aren’t the only risk to the future of some investments. Artificial intelligence (AI) is another source of stress. AI companies will have to show an ROI at some point, and some have begun to set up consulting arms to help enterprises deploy AI.  OpenAI set up OpenAI Deployment Company, and Anthropic launched “a new AI Services company.”⁶ Some software companies face the threat that clients will use AI deployment consultants to help reverse-engineer the form of software for which they’ve paid high prices, historically locked in for as long as five years. If you are an enterprise CFO, you are likely reluctant to renew that five-year contract today.  That poses a threat to software companies, which have been an engine of continued U.S. economic prosperity and stock market gains.

Wealth managers who only offer passive management are also likely to suffer because it seems as though it could be easy for AI to take over managing portfolios of index funds. That’s likely to depress the fees that passive managers charge. The valuations of such firms could fall.

In an environment of less liquidity, I value having liquid assets in client portfolios to ensure we have sufficient cash to buy assets that become attractively priced due to a crisis. A crisis will likely push investors to reduce risk, adding pressure on some companies’ prices. My goal is to preserve liquidity so that I can deploy capital opportunistically during market corrections, asset mispricing, or valuation resets.

As I buy and sell, I’ll also consider that, amid a widespread crisis, Fed Chair Warsh is likely to eventually cut interest rates because, I believe, he understands the risks of inaction as outlined in the paper Rajan co-authored.

In the meantime, I haven’t made many changes in client portfolios during the last quarter. I’m acting defensively by adding some fixed income with an eye to credit quality and shorter maturities, so client assets are less vulnerable to rising interest rates.

As always, thank you for the trust you have placed in 7Summit Advisors and in me. We work hard to earn that trust each day.

Sincerely yours,

Li Chang

1. Viral V. Acharya, Rahul S. Chauhan, Raghuram Rajan, and Sascha Steffen, National Bureau of Economic Research, March 1, 2023 (revised December 2024). https://doi.org/10.3386/w31050.
2. Board of Governors of the Federal Reserve System. “Federal Reserve Announces the Leadership and Objectives of Its Task Forces to Advance the Conduct of Monetary Policy,” n.d. https://www.federalreserve.gov/newsevents/pressreleases/monetary20260709a.htm.
3. Sablik, Tim. “The Fed Is Shrinking Its Balance Sheet. What Does That Mean?” Richmond Fed, January 17, 2025. https://www.richmondfed.org/publications/research/econ_focus/2022/q3_federal_reserve.
4. Acharya et al., p. 1.
5. Alun John, Dhara Ranasinghe, Ankur Benerjee and Gertrude Chvez-Dreyfuss, “Global Bond Rout Deepens, Pushes US Treasury Yields to 24-Year Peak.” Reuters, October 1, 2026. https://finance.yahoo.com/economy/policy/articles/10-treasury-yield-hits-5-183135691.html
6. Jose Antonio Lanz, “OpenAI Just Launched a Consulting Arm to Help Companies Deploy AI,” Yahoo Finance, May 11, 2026 (https://finance.yahoo.com/sectors/technology/articles/openai-just-launched-consulting-arm-151515870.html), Yahoo Finance article. Anthropic, “Building a New Enterprise AI Services Company with Blackstone, Hellman & Friedman, and Goldman Sachs,” May 4, 2026, Anthropic News. https://www.anthropic.com/news/enterprise-ai-services-company