• Fed’s new policy of obscurity heightens risk of a market surprise
• Multiple hikes would likely put pressure on new equity issuance
• Energy an attractive hedge with Westinghouse and Ignis IPOs pending

As US and European investors begin to think about decamping to a beach for summer, the last thing they will want on their mind is interest rates.

Well, good luck with that.

The on and off war between the US and Iran in the Persian Gulf has dampened any near-term hopes of taming inflation and could, if the conflict is prolonged through the rest of the year, prompt a more hawkish stance from central banks, particularly the US Federal Reserve.

Previous Federal Reserve chairs put communication and transparency at the heart of their market approach. Fed meetings have become a routine confirmation of an already expected outcome, the chance for a rate surprise has for many years been negligible.

Last week, though, new Fed Chair Kevin Warsh decided to do away with all that and indicated he would end this long-held practice of Federal Reserve forward transparency at the most important of junctures for global markets. The reviews of his performance were scathing.

Warsh’s subpar performance was overlooked by an equity market rally on the same day, driven by non-connected factors, namely impressive results for Microsoft and an uplift in AI stocks following Citadel’s purchase of huge chunks of AI stock from fund Situational Awareness, removing a forced seller from the market.

South Korea’s Kospi index rallied a huge 17.9% in a single day as chip makers rose in response.

This positive upward move, after a bruising time for tech stocks, should not blind ECM participants to the problems at the Fed, as clearly shown by the bond markets.

Evaporating faith in the credibility of the leadership of the world’s most important central bank and its long-term direction has sent 30-year US Treasury yields to their highest levels since 2007, the US 10-year yield is also edging closer to those levels.

Rate prediction markets are also now all over the place.

According to CME’s Fed Watch Tool, as of Friday 31 July, markets were baking in a 24% chance of one hike by the end of the Fed’s meeting next July, one year from now.

Markets predicted a 34% chance of two rate rises over the next 12 months and a 24% chance of three hikes over the same period. Let confusion reign.

By this morning (Monday 3 August), there was a slightly more dovish tone in the futures markets, driven mainly by US President Donald Trump’s decision to call off strikes against Iran over the weekend and a possible resumption of talks between the two nations.

Markets shouldn’t hold their breath too much given the US president’s attempts to end the war are starting to resemble King Canute’s struggle against the tide.

This is what makes a lack of Fed transparency so dangerous; in an uncertain geopolitical environment, investors need some indicators on what might move the dial on rates.

One equity banker noted markets were clearly “nervous” following Warsh’s comments, adding that the bond market reaction was a cause for concern, despite the equity rally.

“Warsh has emphasised the importance of price stability but, to date, has not taken action,” an investor added. “The bond market is signalling that higher interest rates are warranted.”

Positioning for anything

On Friday, Fed futures markets were pricing in a 65% chance of a rate rise in September, according to CME Fed Watch. This has held despite the cancellation of the US strikes over the weekend.

Even if the Fed only hikes once, higher-for-longer rates appear to be the baseline consensus for most market watchers. The same also looks true of the ECB in Europe; the Bank of England may make do with ‘hold’ for the rest of the year.

“If the Fed were to raise rates, it would likely pressure equity valuations and, by extension, the market for new issuance,” noted the investor. “While that could create some short-term pain, the equity markets remain supportive of new issuers until such action is taken.”

Rising rates would cause a headache for equity capital markets after a euphoric start to the year, with 2026 well on track to be one of the best years for global equity dealmaking on record.

The latest global rate hiking cycle from 2022 through to 2023 led to lower global ECM issuance, as investors switched to bonds and fled from low-profit growth businesses.

Source: Dealogic, global ECM issuance pricing fate by full year

While one rate hike could slow momentum for stocks, a prolonged hiking cycle could be particularly harmful.

The largest impact would likely be seen on high-growth, high capex, AI businesses as higher weighted average cost of capital diminishes their terminal values.

Even if deals were still possible, a rising rate environment would likely cause investors to ask for wider discounts, even for high-quality large sector names like Anthropic.

“The more expensive capital is, and the larger the unknown capital outlay before profitability, the bigger the discount a company takes going public,” noted an ECM advisor. The reason, he said, is that it has to de-risk how it gets to cash flow, and how much it may dilute its cap table, since cash isn’t free.

“Interest rates and the cost of capital will remain a continued focus for the capital markets, especially in high-growth areas that need a lot of capital to reach maturity,” the ECM adviser added.

While financial stocks are normally a strong hedge in a rising rate environment, faster than expected rate rises might deteriorate credit quality, causing banks to come under pressure as well.

Another sector that market participants pointed to as a strong hedge in an unknown environment of lower or higher rates is energy.

It is already a popular investment given the huge power consumption of AI data centres, a trend that will continue in a lower rate environment. But high cash generation, and strong margins, means that in a higher rate environment these stocks remain an effective safe haven.

Large sales in listed energy businesses have contributed billions of dollars in ECM deal volume already this year, partly in the form of accelerated bookbuilds, like the USD 3.1bn placement in Constellation Energy in the US, or the several sell-downs in Spanish-listed Naturgy.

But energy companies seeking to invest in modernisation or to undertake transformative M&A have also been raising primary equity. Examples include Athens-listed Public Power Corp’s EUR 4.2bn cash call for investment in grids and data centres, and Engie’s EUR 3bn placement to raise acquisition funds for the takeover of UK Power Networks.

There are several more of these primary cap raises on the cards before the end of the year, noted the banker.

There are also likely to be opportunities in the IPO market in the months ahead, potentially with the listing of US nuclear power company Westinghouse, which filed for an IPO at the end of last week, or Spanish renewable energy company Ignis.

With the rest of the year looking more uncertain in terms of rates, the war in the Gulf, or even just the sustainability of AI growth stocks, investment in energy might just provide investors an ideal hedge. On the upside, data centre growth means demand for electricity continues to increase. On the downside, the need for grid modernisation to encompass a wider variety of energy sources remains undiminished.

Whatever happens we will always need power.