Quarterly Insights: October 2026
The End of Free Money?
The U.S. economy continues to defy simple explanation. Nowhere is this clearer than in shifting rate expectations. To begin the year, investors debated how quickly the Federal Reserve would cut interest rates. The question today is how much further rates may need to rise.
In September, under new Chair Kevin Warsh, the Federal Reserve raised its benchmark rate by 0.25% to 3.75-4.00%. Long-term bond yields have seen an even more dramatic increase and are now close to their highest levels this century. Many Americans are feeling the effects: mortgage rates are well above 7%, and higher borrowing costs for credit cards and car loans are hurting a consumer already struggling under the weight of inflation.
It would be easy to interpret higher interest rates as a harbinger of bad things to come, but we see it differently. Higher rates partly reflect resilience. The economy has absorbed the conflict in the Middle East and an energy supply shock better than many expected it could. Higher rates also mark the end of nearly free money (when adjusting for inflation) that followed the 2008 financial crisis.
Normalizing interest rates means capital has a real cost, again. While that might mean a return to traditional economic cycles (setting aside the brief contraction during the 2020 pandemic, we have not experienced a recession in over 15 years), a higher cost of capital also rewards discipline. In this letter, we examine the forces behind this shift and why it supports our approach to investing.
An Economy That Has Bent but Not Broken
The global economy has been growing at a respectable rate that is expected to continue into 2027. That growth has been supported by a surge in domestic infrastructure spending around the world—a response to a fractured political climate and concerns about the erosion of old global alliances.
Global growth should not be confused with uniform or lasting strength. For example, most of Europe continues to contend with aging demographics and a lackluster innovation culture; once the world’s undisputed growth engine, China is running at two speeds with strong high-tech manufacturing but soft consumer spending. Even as the global economy has held firm, investors have real concerns about the long-term sustainability of government finances, reflected in the synchronous rise of bond yields around the world.
Domestically, federal deficit spending has reignited warnings about the long-term health of the U.S. economy. While the trend is concerning, past crises (such as the 2008 Great Financial Crisis) resulted from pervasive weakness across household, corporate, and bank balance sheets. Today, private sector balance sheets remain generally healthy, even if federal finances have weakened.
This is not to suggest a market correction couldn’t occur. But our base case is not a repeat of 2008. U.S. households carry lower leverage and enjoy stronger debt-service capacity than they did two decades ago. Meanwhile, banks maintain meaningful capital buffers and liquidity, which do not eliminate the possibility of downturns but do significantly reduce the risk that isolated incidents cascade into systemwide failures.
Demanding More For Your Money
A rise in bond yields has ripple effects. U.S. Treasury yields provide a benchmark for pricing mortgages, corporate debt, stocks, and other financial assets. When risk-free government bonds offer attractive yields, investors naturally require correspondingly higher returns on riskier investments.
Conversely, when money is cheap and abundant, firms are more willing to invest in speculative or unproductive endeavors: low-margin expansions, technology bets, and market-share grabs with no clear path to profitability. Japan’s “Lost Decades” serve as a cautionary tale. Ultra-low rates helped improve short-term market sentiment in the wake of Japan’s 1990s stock market and real estate crash but also ushered in an era of so-called zombie firms. Similarly, the recent low-rate regime in the U.S. fueled a boom in cryptocurrencies, social media-hyped “meme” stocks, and blank check companies called SPACs that provided a shortcut for speculative companies to go public.
The return of a meaningful cost of capital may have serious implications for the AI trade. Building the AI ecosystem requires enormous spending on data centers, semiconductors, power infrastructure, and equipment. A growing share of the investment is being financed through debt and long-term lease commitments.
This represents an important change in the AI industry’s risk profile. Equity capital is more forgiving towards slow starts and unclear economics than debt is. That is, borrowing forces unproven business models onto a fixed repayment schedule. To meet those obligations, providers face pressure to raise prices and reduce subsidies. Those pressures are even greater when the cost of funding rises.
Looking Ahead with Confidence
A period of more expensive capital may feel unfamiliar after years of low rates, but it can also create a healthier investment environment. We view today’s higher interest rates not as an obstacle to endure but as a return to the responsible pricing of risk.
Navigating the shift to a higher cost of capital does not require predicting the Fed’s next move or timing economic cycles. Recessions, while challenging, are a normal mechanism for reallocating capital toward its highest and best uses. We believe success follows from staying focused on enduring principles: owning resilient businesses, demanding appropriate risk compensation, and focusing on tangible long-term value creation. Today’s market environment may present challenges, but it could establish a better foundation for building and preserving wealth.
The above information is for educational purposes and should not be considered a recommendation or investment advice. Investing in securities can result in loss of capital. Past performance is no guarantee of future performance.
