[WASHINGTON] The US central bank has stopped treating energy-driven inflation as temporary.

For much of 2026, the question hanging over markets was when the US Federal Reserve would resume cutting rates. At its September meeting, the Fed answered a different question.

It raised the Fed funds rate by 25 basis points to 3.75 to 4 per cent, its first hike since July 2023, and the vote was unanimous. Its updated projections indicate another increase before the year-end and no cuts in 2027.

Some investors will call this a policy mistake. The inflation the Fed is fighting comes largely from the Middle East conflict, and higher interest rates cannot reopen shipping lanes or restart refineries.

That criticism misreads what the Fed is trying to do. Understanding its logic matters for how portfolios should be positioned from here.

Why hike into a supply shock?

Central banks usually “look through” energy shocks, on the view that they lift prices once and then fade. The Fed has explicitly stopped doing so.

Its latest statement no longer attributes elevated inflation to supply shocks in sectors such as energy.

At the recent September Federal Open Market Committee press conference, Fed chair Kevin Warsh argued that the central bank cannot fix the source of the shock, but can limit how far it spreads.

The real concern is diesel more than petrol. Brent crude has climbed from about US$87 a barrel in July to around US$107 in the middle of September, but the more acute strain is in refined products.

Attacks on Russian and Middle Eastern refineries, and run cuts by crude-starved Asian refiners, have pushed the US refining system to around 98 per cent utilisation.

The US diesel crack spread, which is the margin between crude and the diesel refined from it, has widened to more than US$100 a barrel.

Before the conflict, it ranged between roughly US$15 and US$30.

Diesel moves trucks, trains, ships and farm machinery, so its costs seep into prices far beyond the energy component of inflation. That transmission is already visible. Transportation and warehousing prices rose 2.3 per cent in August’s producer price data.

Food prices have not yet reacted, but they typically respond last.

Food inflation eased to 2.7 per cent year on year in August. Grocery prices rose 2.2 per cent and were flat on the month.

However, food production is energy-intensive at every stage. Diesel runs farm equipment and freight. Natural gas, much of it shipped through Hormuz, is a key input for fertiliser. Carriers add fuel surcharges once diesel prices pass set thresholds.

The latest inflation and jobs data gave the Fed a reason to wait. Core personal consumption expenditure inflation, its preferred gauge, has held at 3.3 per cent for three months.

Monthly core consumer price index readings have picked up, from flat in June to 0.3 per cent in August.

August payrolls also came in at roughly three times the expected amount. One strong print does not make a robust labour market, but the Fed only needed evidence that the job market had stopped deteriorating.

Long-term yields not just about inflation

The US 10-year Treasury yield closed at about 5 per cent after the decision, its highest level since 2007.

It is tempting to read this purely as an inflation story, but Warsh indicated a second driver: competition for capital.

Governments continue to borrow heavily. Meanwhile, the large technology companies building out artificial intelligence infrastructure are increasingly tapping debt markets to fund record capital expenditure.

That demand for funding pushes long-term yields up, regardless of the Fed’s decision at any single meeting. Investors should therefore not assume long-dated bonds will rally, simply because inflation eventually cools.

What this means for portfolios

In fixed income, keep duration short. Shorter-dated bonds return your capital sooner and are far less exposed to further swings in long-term yields.

For Singapore-based investors, short-duration Singapore dollar bond funds and cash-management solutions offer a reasonable yield.

In equities, favour profits that arrive sooner, rather than later. Higher rates reduce the present value of earnings expected far in the future. Companies that are already profitable and reasonably valued tend to hold up better than those with share prices resting on distant growth.

This supports a tilt towards Asia, where markets broadly trade at a meaningful discount to the US for comparable earnings growth. Within the region, three areas stand out.

One, Asian semiconductor makers have strong balance sheets and demand underpinned by multi-year contracts, yet their valuations still trail those of US peers.

Two, China’s technology sector is seeing AI-related demand feed through to earnings.

Three, for Singapore, dividend-paying stocks offer income today, which is precisely what tends to be rewarded when rates stay high.

Our one exception to US caution is Internet names, or large-cap profitable companies.

Most hyperscalers have underperformed this year, and their valuations have compressed to below historical averages while earnings held up. That does not make them cheap, but less of their price rests on distant profits.

What would change the picture?

Two developments would challenge the higher-for-longer view.

The first is de-escalation in the Gulf that restores reliable shipping routes and eases the squeeze on diesel. A sharp fall in energy prices would weaken the case for further tightening.

The second is a renewed slide in the labour market. August’s hiring surge sits against a 12-month average of about only 31,000 jobs a month, and participation remains below the level it began the year at.

Investors should watch the September and October inflation reports closely. Those reports will capture more of the recent surge in fuel costs than August did.

Until then, the Fed’s message is clear. Warsh said he would be hard-pressed to call broad financial conditions restrictive.

A central bank that does not consider 4 per cent tight is prepared to go further. Investors would do well to position for rates that stay higher for longer, rather than wait for a pivot the Fed itself no longer projects.

The writer is a research analyst with the global fixed income team of FSM Global, the B2C division of iFAST Financial, which is the Singapore subsidiary of iFAST Corporation