Written by Steve Andrews
Market Performance and Interest Rates
September has a reputation for being a difficult month for stocks, and 2026 has largely lived up to that history. However, the bond market has experienced even greater weakness than equities this month.
The yield on the 10-year Treasury note rose above 5.00% for the first time since 2007, climbing more than 25 basis points since the end of August. Meanwhile, the 2-year Treasury yield, which is more sensitive to Federal Reserve policy, increased by 30 basis points to 4.68% by mid-month, its highest level since July 2024.
Inflation has contributed to the rise in yields, as investors require higher returns to compensate for diminished purchasing power. At the same time, stronger economic growth has increased demand for capital, putting additional upward pressure on interest rates.
Historical Perspective on Treasury Yields
Although a 5.00% yield on the 10-year Treasury may seem elevated by recent standards, it remains relatively consistent with historical relationships between inflation and long-term interest rates.
Prior to the 2008 financial crisis, the 10-year Treasury yield typically averaged 150 to 175 basis points above inflation. With Personal Consumption Expenditures (PCE) inflation running at 3.7% in July, that historical relationship would imply a 10-year Treasury yield between approximately 5.20% and 5.45%.
That relationship changed following the Great Recession. Between 2010 and 2020, inflation averaged roughly 1.7%, which would normally have supported a 10-year yield above 3%. Instead, the average yield remained near 2.25%. One reason was strong global demand for U.S. Treasury securities, as investors prioritized safety and liquidity following the financial crisis.
Federal Reserve Policy and the September FOMC Meeting
Investors have become increasingly focused on persistent inflation, growing federal deficits, and continued economic resilience. These factors have contributed to higher long-term interest rates and increased scrutiny of monetary policy.
At its September 16 meeting, the Federal Open Market Committee (FOMC) unanimously raised the federal funds target range by 25 basis points to 3.75% to 4.00%, marking the first rate increase since July 2023. The Committee stated that inflation remains elevated and that the policy move is intended to support a more timely return to its 2% inflation objective. Updated projections suggest that most policymakers anticipate the possibility of at least one additional rate increase before year-end.
Federal Reserve Chair Kevin Warsh stated that recent inflation readings have not provided sufficient evidence that underlying inflation trends are improving quickly enough and noted that the economy continues to show signs of strength.
The Fed's updated economic projections reflected a modestly stronger outlook. Expected GDP growth for 2026 increased from 2.2% to 2.3%, while projected unemployment was lowered from 4.2% to 4.1% for both 2026 and 2027. Policymakers expect inflation to average 3.7% this year before moderating to 2.3% in 2027 and 2.1% in 2028.
Economic Growth Remains Resilient
Despite ongoing concerns surrounding inflation, interest rates, geopolitical developments, artificial intelligence, and federal deficits, the U.S. economy continues to demonstrate resilience.
The latest Weekly Economic Index from the Bureau of Economic Analysis rose 3.3% year over year for the week ending September 11, reaching its highest level in four years. Broader indicators also suggest that economic activity and employment continue to trend higher.
Labor Market Strength
Following a softer July report, employment rebounded sharply in August.
Nonfarm payrolls increased by 162,000 jobs, while revisions added another 55,000 jobs to June and July totals. Private-sector payrolls accounted for 127,000 of those gains. The Household Survey, which is used to calculate the unemployment rate, showed employment increasing by 569,000.
Because the labor force expanded by 683,000 people during the month, the unemployment rate remained unchanged at 4.1%. Labor force participation increased to 61.6%, its first rise in nine months.
Average hourly earnings increased 0.3% in August and were up 3.1% from a year earlier. Employment gains also broadened across industries, with nearly 56% of sectors adding workers, the highest share in more than four years.
Income Growth and Labor Market Quality
Labor market conditions remain healthy beyond the headline employment numbers.
The number of full-time workers increased by 735,000 in August, while part-time employment declined by 223,000. Although wage growth of 3.1% trails current PCE inflation, total labor income, which accounts for both wages and hours worked, rose 4.3% from a year ago.
Job openings remain steady at approximately 7.3 million, while layoffs, separations, and initial unemployment claims continue to hover near historically low levels.
Consumer Spending Continues to Support Growth
Consumer spending remains a key driver of economic expansion.
Retail sales increased 1.2% in August. While higher gasoline prices contributed to overall growth, core retail sales, excluding gas stations, rose 1.3%. Third-quarter core sales are currently tracking at a 4.8% annualized growth rate following a strong second quarter.
Online sales also reached a new high. Weekly same-store sales data from Johnson Redbook show sales averaging 8.6% above year-earlier levels during the past eight weeks, further indicating sustained consumer demand.
Manufacturing, Services, and Productivity
Both the manufacturing and services sectors expanded in August, and forward-looking indicators such as new orders, production, and business activity suggest continued growth in the months ahead.
Order backlogs continue to rise as firms work to meet demand. At the same time, productivity improvements are helping businesses expand output efficiently.
Manufacturing productivity increased 2.4% during the second quarter, while first-quarter growth was revised upward from 1.9% to 2.2%. Manufacturing output is estimated to have grown at a 5.4% annualized pace in the second quarter, the strongest increase since mid-2021.
These gains helped keep labor-cost pressures contained. Unit labor costs in manufacturing declined at a 0.3% annualized rate during the quarter, reducing concerns about a sustained wage-price spiral.
Entrepreneurship and Business Formation
Entrepreneurship remains an important source of economic growth and innovation.
Since 2024, nearly 500,000 new businesses have applied for federal tax identification numbers each month. During the last three months, monthly applications have exceeded 575,000, placing the annual pace close to 7 million new business formations. Importantly, the growth is not limited to small side businesses. Applications categorized as "high-propensity," which are statistically more likely to become employer firms, remain well above pre-pandemic levels.
Almost one-quarter of new applications are concentrated in professional, scientific, and technical services. While many new ventures will not succeed, those that do can contribute meaningfully to future employment, investment, and economic output.
Inflation Outlook and Future Fed Actions
The Federal Reserve's dual mandate is to promote maximum employment and maintain price stability. Employment conditions currently appear relatively stable, while inflation remains above the Fed's long-term target.
As a result, additional rate increases remain possible. However, modest adjustments to the federal funds rate are unlikely, by themselves, to derail an economy that continues to show positive momentum.
Energy prices have been a significant contributor to recent inflation pressures. Should energy markets stabilize, those effects could begin to ease. At the same time, broader monetary growth trends remain considerably more restrained than the surge experienced in 2020 and 2021, which contributed to the inflationary environment that followed.
Outlook
The economy continues to face a number of challenges, including inflation, rising interest rates, fiscal concerns, geopolitical uncertainty, and rapid technological change. Nevertheless, current indicators suggest that underlying economic momentum remains intact.
Current estimates for third-quarter GDP growth range from 4.0% to 5.0%, while corporate earnings expectations remain near record highs. Supported by consumer spending, business investment, productivity growth, and labor market resilience, the U.S. economy appears positioned to continue expanding despite ongoing headwinds.
