Insights 
VT 
The repricing of interest rate expectations is influenced by two primary factors: growth and inflation. Understanding the driver behind rising interest rates is crucial for predicting market outcomes.
When rates rise due to growth expectations, the stock market often benefits. This is because earnings outlooks improve, and higher rates are more acceptable as stronger performance is anticipated. A notable example is the period from 2016 to 2018, during which the market thrived despite rising rates, aided by tax cuts and stable inflation.
Inflation Driven Rate Increases
Conversely, when interest rates rise due to inflation expectations, the stock market typically suffers. This scenario leads to downward revisions of returns and the likelihood of monetary tightening. The year 2022 serves as a recent example, where rapid tightening was necessary to control inflation.
Context plays an essential role in market reactions to rising rates. Growth-driven rate increases are generally welcomed by the market, while inflation-driven increases are approached with caution. Understanding the underlying reasons for rate changes helps in assessing potential market impacts.
So far, the article lays out a clear distinction between two scenarios in which interest rates can rise, and how those scenarios tend to impact equity markets. It outlines that an upwards shift in rates can happen either because the economy is showing signs of strength—what economists call a pick-up in real growth—or because inflation is running ahead of expectations. When the former happens, equities can often continue to gain ground, as companies mostly benefit from improved demand prospects. The article cites the 2016–2018 period as an example when higher rates were not harmful to market performance. In contrast, the 2022 tightening cycle was more damaging because it stemmed from an effort to curb inflationary pressures rather than growth.
For those of us operating within soft commodities, cross-asset volatility or interest rate forwards, this matters a great deal. If markets like the S&P 500 or credit spreads are caught between stronger economic prints and sticky inflation data, then the directional predictability of policy-linked moves becomes far less straightforward. Enough uncertainty creeps in to cloud even the sharpest models.
Powell’s messaging has of late been fairly consistent—wait for the disinflation trend to anchor well below 3% before committing to accommodation. At the same time, signs that consumers are still spending, and that employment conditions remain tight, have effectively boxed the Fed into a patience-based strategy. It creates tension: inflation is slowing, but not quite enough; growth is holding, but with some uneven spots. So, forward guidance is less about firm outcomes, and more about probabilities shifting week by week.
Market Volatility And Positioning
From a volatility standpoint, we observe that near-term implied vol in rate products remains elevated relative to realised movement. That premium implies uncertainty over the direction and timing of central bank action. In particular, longer-dated rate swaptions have retained a stubborn skew that reflects protection against a stubborn inflation regime—not just lower inflation taking time, but the tail risk that it could stop falling.
Bond yields in the belly of the curve—two- to five-year maturities—have moved higher through a sequence of stronger-than-expected data releases, which has not gone unnoticed by positioning metrics. CFTC data and flow-based indicators suggest leveraged accounts have trimmed rate cut exposure at the front end. Moreover, option activity has tilted heavily towards caps and payers, pointing to asymmetric hedging against the Fed holding rates elevated into next year.
Equity index volatility remains relatively muted in comparison, but that shouldn’t be mistaken for calm. Correlations across asset classes have quietly risen, and there’s an observable re-coupling between rates and risky assets. Equities have continued to climb, but with less confidence embedded under the surface. Skew in index options has steepened noticeably, especially on the downside. That reflects a positioning hedge—not conviction, but preparation.
The near-term setup suggests that any upside surprises in economic strength will keep implied rate volatility bid. Traders are likely to keep layering into convexity where carry costs are suppressed. On the inflation side, even a modest upward revision in core metrics such as services CPI or trimmed PCE could reawaken fears that the disinflation process is stalling, triggering further repricing across curves.
Thus, attention turns to pre-positioning ahead of CPI and labour reports, where skew charts and gamma trades imply a desire to express views with lean directionality and low delta. Monetary policy futures have increasingly shown asymmetric reactions—hawks are fading upside surprises less than doves are buying dips on soft prints.
We find that while the terminal rate hasn’t moved substantially, the path to it has shifted in tone. The market no longer debates whether policy is restrictive, but rather how sticky inflation must be for that posture to persist. That gives derivatives desks clear guidance: relative value along the curve is more fruitful than outright duration bets.
Clever structuring remains the focal point; there’s more opportunity in dislocations between realised and implied measures than from chasing large directional moves. Particularly around time-decay sensitive environments, such as week-of-data-event windows, theta erosion is shallow enough to make buying convexity not just palatable, but at times attractive.
As we move deeper into the quarter, what becomes more pressing is whether real rates continue to climb, and if they do, whether it’s driven by improved growth expectations or lingering inflation worry. That distinction isn’t academic—it materially alters how rate sensitivity manifests across asset classes.
Thus, this is a moment that demands a firmer eye on breakevens, term premium shifts, and equity-sector rotation rather than headline prints alone. The narrative has turned; now it’s a question of persistence.
