Rising Rates, Resilient AI: Markets Face a Pivotal Fed Moment
Stuart Katz
Executive Summary
The S&P 500 returned -0.8% as a jump in oil prices and two hot inflation gauges drove bond yields higher. Mid-cap stocks (-1.7%) and small-cap stocks (-2.4%) both fared worse than large caps. Within the S&P 500, energy (+2.1%) and communication services (+1.1%) were the only sectors with gains; healthcare (-3.5%) and materials (-2.7%) were the worst performing. EAFE markets returned -1.4% with losses in Europe (-1.7%) and the U.K. (-1.6%), while EM markets returned -0.2% with gains in Korea (+4.1%) offset by losses in China (-2.8%) and India (-2.8%).
The bond market really struggled to digest the inflation data and rising oil prices last week. To start, the 2-year Treasury yield surged 16 basis points to 4.63% as the bond market priced in a greater likelihood of rate hikes.
Amid the bond volatility, stocks rallied Friday, leaving only modest corrective price action. The MSCI All Country World Index is down just 1.40% from its all-time highs. The combination of energy and technology sector strength continues to support global equity markets. From non-U.S. value stocks in energy to semiconductor stocks in South Korea and Japan, global equities have yet to price in any meaningful risk.
Inflation expectations barely budged last week, with the 10-year TIPS breakeven rate up just 1 bp. The curve flattened over the week, suggesting the bond market may not be buying the better growth story that is being priced into short-term rates.
As for fixed income, the 10-year Treasury yield rose to 4.97% over the week, and the 2s/10s Treasury yield spread flattened to +35 bps. High-yield bond spreads tightened to 265 bps over the week. Instead of their typical inverse relationship, stocks and bonds have been moving in lockstep in 2026. The correlation between the S&P 500 Index and Treasuries has remained positive since March and hit a 30-year high of 0.77 in June 2026.
Key Takeaways
1. Labor-market conditions improved in August after several weak months of hiring. Employers added +162,000 jobs, while the unemployment rate held at 4.1%. Prior months also looked better after revisions: June payroll growth was raised to +31,000 from +20,000, and July was revised from an initially reported -23,000 jobs to +21,000. Combined, the revisions added +55,000 jobs to the previous two months. The report does not suggest the labor market has returned to the strength of earlier years, but it paints a less concerning picture than investors saw after July’s initial release. Implication – The labor market still appears to be cooling, but August suggests that deterioration is occurring more gradually than previously feared.
2. The Middle East conflict is becoming harder for markets to treat as a temporary disruption. Oil prices moved sharply higher as fighting intensified and disruptions to energy shipments through the Strait of Hormuz continued. U.S. crude moved back above $100 per barrel after falling substantially earlier in the summer. More importantly, repeated escalations are making it harder to assume that each increase in energy prices will quickly unwind. Implication – The longer the disruption persists, the more relevant energy becomes as an ongoing source of inflation uncertainty rather than a series of isolated weekly price swings.
3. Long-term borrowing costs continue to rise across global bond markets. The 10-year Treasury yield climbed above 4.90% last week, its highest level since October 2023, while the 30-year moved above 5.3%. Government-bond yields also rose across several major developed markets as investors weighed inflation, higher energy costs, government borrowing needs, and tighter monetary policy. The breadth of the move suggests that higher long-term rates are not simply a reaction to one U.S. economic report or a shift in Fed expectations. There still should be slow-motion disinflation in the pipeline from housing. U.S. 30-year mortgage rates surged back above 7% last Friday. Implication – A wider set of global forces is putting upward pressure on long-term borrowing costs, making it harder to attribute elevated yields to any single economic report or shift in central-bank policy.
4. Expectations for a rate hike have been building ahead of this week’s Fed meeting. The Fed held rates at 3.50%–3.75% in July, although three policymakers preferred a +0.25% hike. At Jackson Hole, Chair Warsh described the labor market as stable and said inflation should remain the Fed’s predominant focus. Since then, stronger August job growth, higher oil prices, and renewed producer-price pressure have strengthened the case for an increase. The bond market is now pricing in an 87% chance of a hike at this week’s FOMC September 15-16 meeting. Subsequently, it is pricing in nearly a 50% chance of another hike, with even a fat-tail probability of 27% for a third hike. Implication – This week’s decision will show whether firmer labor data and persistent inflation pressure have been enough to move the Fed from considering a rate hike to delivering one.
5. AI infrastructure spending remains resilient despite the volatile macro backdrop. Oil prices and long-term yields have risen, inflation pressure has increased, and the market expects a Fed hike. Those shifts would normally make large capital projects more expensive and could lead companies to reconsider spending plans. So far, however, the largest tech companies have continued committing substantial capital to data centers, computing capacity, and other AI infrastructure. Implication – AI investment has become a significant contributor to both economic growth and corporate earnings, and so far, the largest tech companies appear willing to continue that spending despite volatility in rates, energy prices, and inflation. AI hyperscalers are spending so much to finance data centers, chips, and infrastructure that the new debt they’ve issued this year reached nearly 70% of new Treasury supply for 2026. The sheer amount of debt being issued by these companies is highlighting how the race to build AI infrastructure is reshaping demand for long-term bonds.
Weekly Commentary
Rising Rates, Resilient AI: Markets Face a Pivotal Fed Moment
Stuart Katz
Executive Summary
The S&P 500 returned -0.8% as a jump in oil prices and two hot inflation gauges drove bond yields higher. Mid-cap stocks (-1.7%) and small-cap stocks (-2.4%) both fared worse than large caps. Within the S&P 500, energy (+2.1%) and communication services (+1.1%) were the only sectors with gains; healthcare (-3.5%) and materials (-2.7%) were the worst performing. EAFE markets returned -1.4% with losses in Europe (-1.7%) and the U.K. (-1.6%), while EM markets returned -0.2% with gains in Korea (+4.1%) offset by losses in China (-2.8%) and India (-2.8%).
The bond market really struggled to digest the inflation data and rising oil prices last week. To start, the 2-year Treasury yield surged 16 basis points to 4.63% as the bond market priced in a greater likelihood of rate hikes.
Amid the bond volatility, stocks rallied Friday, leaving only modest corrective price action. The MSCI All Country World Index is down just 1.40% from its all-time highs. The combination of energy and technology sector strength continues to support global equity markets. From non-U.S. value stocks in energy to semiconductor stocks in South Korea and Japan, global equities have yet to price in any meaningful risk.
Inflation expectations barely budged last week, with the 10-year TIPS breakeven rate up just 1 bp. The curve flattened over the week, suggesting the bond market may not be buying the better growth story that is being priced into short-term rates.
As for fixed income, the 10-year Treasury yield rose to 4.97% over the week, and the 2s/10s Treasury yield spread flattened to +35 bps. High-yield bond spreads tightened to 265 bps over the week. Instead of their typical inverse relationship, stocks and bonds have been moving in lockstep in 2026. The correlation between the S&P 500 Index and Treasuries has remained positive since March and hit a 30-year high of 0.77 in June 2026.
Key Takeaways
1. Labor-market conditions improved in August after several weak months of hiring. Employers added +162,000 jobs, while the unemployment rate held at 4.1%. Prior months also looked better after revisions: June payroll growth was raised to +31,000 from +20,000, and July was revised from an initially reported -23,000 jobs to +21,000. Combined, the revisions added +55,000 jobs to the previous two months. The report does not suggest the labor market has returned to the strength of earlier years, but it paints a less concerning picture than investors saw after July’s initial release. Implication – The labor market still appears to be cooling, but August suggests that deterioration is occurring more gradually than previously feared.
2. The Middle East conflict is becoming harder for markets to treat as a temporary disruption. Oil prices moved sharply higher as fighting intensified and disruptions to energy shipments through the Strait of Hormuz continued. U.S. crude moved back above $100 per barrel after falling substantially earlier in the summer. More importantly, repeated escalations are making it harder to assume that each increase in energy prices will quickly unwind. Implication – The longer the disruption persists, the more relevant energy becomes as an ongoing source of inflation uncertainty rather than a series of isolated weekly price swings.
3. Long-term borrowing costs continue to rise across global bond markets. The 10-year Treasury yield climbed above 4.90% last week, its highest level since October 2023, while the 30-year moved above 5.3%. Government-bond yields also rose across several major developed markets as investors weighed inflation, higher energy costs, government borrowing needs, and tighter monetary policy. The breadth of the move suggests that higher long-term rates are not simply a reaction to one U.S. economic report or a shift in Fed expectations. There still should be slow-motion disinflation in the pipeline from housing. U.S. 30-year mortgage rates surged back above 7% last Friday. Implication – A wider set of global forces is putting upward pressure on long-term borrowing costs, making it harder to attribute elevated yields to any single economic report or shift in central-bank policy.
4. Expectations for a rate hike have been building ahead of this week’s Fed meeting. The Fed held rates at 3.50%–3.75% in July, although three policymakers preferred a +0.25% hike. At Jackson Hole, Chair Warsh described the labor market as stable and said inflation should remain the Fed’s predominant focus. Since then, stronger August job growth, higher oil prices, and renewed producer-price pressure have strengthened the case for an increase. The bond market is now pricing in an 87% chance of a hike at this week’s FOMC September 15-16 meeting. Subsequently, it is pricing in nearly a 50% chance of another hike, with even a fat-tail probability of 27% for a third hike. Implication – This week’s decision will show whether firmer labor data and persistent inflation pressure have been enough to move the Fed from considering a rate hike to delivering one.
5. AI infrastructure spending remains resilient despite the volatile macro backdrop. Oil prices and long-term yields have risen, inflation pressure has increased, and the market expects a Fed hike. Those shifts would normally make large capital projects more expensive and could lead companies to reconsider spending plans. So far, however, the largest tech companies have continued committing substantial capital to data centers, computing capacity, and other AI infrastructure. Implication – AI investment has become a significant contributor to both economic growth and corporate earnings, and so far, the largest tech companies appear willing to continue that spending despite volatility in rates, energy prices, and inflation. AI hyperscalers are spending so much to finance data centers, chips, and infrastructure that the new debt they’ve issued this year reached nearly 70% of new Treasury supply for 2026. The sheer amount of debt being issued by these companies is highlighting how the race to build AI infrastructure is reshaping demand for long-term bonds.
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