In the third quarter, markets absorbed higher rates, rising oil prices, and renewed inflation concerns, and continued to advance. Strong earnings, consumer spending, and sustained AI-related investment kept growth intact, although that CAPEX may also be reinforcing a higher-for-longer rate environment. The result for investors is a broader opportunity set, highlighted by improved income in bonds, continued support for risk assets, and a greater premium on selectivity.
Higher bond yields represent a risk, but context matters, as part of the increase in yields is attributable to better growth. The employment conditions remain broadly stable despite various headwinds from inflation pressures, higher rates, growing deficits, and elevated oil prices. The predominant tailwind behind the resilient labor market is growing corporate profits and the benefits of substantial AI capex.
Key Takeaways
1. The U.S. economy was stronger in the first half of the year than previously estimated.
Q2 GDP growth was revised to a +2.2% annualized rate from the +1.5% initially reported, while Q1 growth was revised up to +2.5% from +2.1%. Underlying demand was even stronger: a measure of consumer spending and private fixed investment increased at a +4.6% rate in the second quarter, the strongest pace since early 2023. The upward revisions reflected stronger consumer spending and business investment. Implication – The updated figures show that the economy entered the second half with considerably more momentum than the earlier estimates suggested.
2. Strong consumer spending has been one source of that economic strength.
Personal consumption expenditures increased +0.9% in August, with spending growing +0.6% after adjusting for inflation. However, personal income only increased by +0.2%, and after-inflation disposable income remained unchanged. Consumers bridged part of that gap by saving less, with the personal savings rate falling to 4.1% from 4.6% in July. Implication – Consumer spending remains strong despite weak confidence, but August’s gains relied partly on households saving less as spending grew faster than income.
3. AI investment has also contributed to economic growth.
Business investment remained strong in Q2, with continued spending on computing equipment, software, and other intellectual property. Micron’s latest earnings provided a fresh look at the scale of the buildout. Quarterly revenue reached a record $54.2 billion as demand from cloud and data center customers increased sharply, and the company projected roughly $61.5 billion of revenue for the current quarter. Implication – The AI boom is increasingly visible in the broader economy, with spending on the infrastructure needed to build and run AI systems contributing to strong investment growth.
4. Long-term Treasury yields continue to rise, touching their highest levels in more than two decades.
The 10-year Treasury yield rose above 5.30%, while the 30-year yield approached 5.70%. Both yields now sit at their highest levels since 2002. Stronger economic growth helps explain part of the upward pressure, but persistent inflation, heavy government borrowing, and broader global bond-market weakness have also contributed to rising long-term rates. Shorter-term yields were steadier this week, underscoring that the move is about more than expectations for the next Federal Reserve decision. Implication – Rising long-term rates are tightening financial conditions by raising borrowing costs for mortgages, corporate debt, and other parts of the economy.
5. Higher interest rates are weighing on much of the stock market, while strong AI growth is helping the largest technology companies hold up better.
The market-cap-weighted S&P 500 has fallen about -2% from its mid-August high, but its equal-weight counterpart has fallen around -6% over the same period, showing that the typical stock has experienced a more difficult environment than the headline index suggests. Higher bond yields have created a tougher backdrop for many companies, while exceptionally strong earnings and investment tied to AI have continued to support several of the market’s largest technology stocks. Implication – Market leadership has become increasingly concentrated, reflecting both a tougher rate environment for many companies and strong fundamental growth in a small group of technology stocks
Weekly Commentary
AI Pushes Markets Forward Despite Rising Yields
Stuart Katz
Executive Summary
In the third quarter, markets absorbed higher rates, rising oil prices, and renewed inflation concerns, and continued to advance. Strong earnings, consumer spending, and sustained AI-related investment kept growth intact, although that CAPEX may also be reinforcing a higher-for-longer rate environment. The result for investors is a broader opportunity set, highlighted by improved income in bonds, continued support for risk assets, and a greater premium on selectivity.
Higher bond yields represent a risk, but context matters, as part of the increase in yields is attributable to better growth. The employment conditions remain broadly stable despite various headwinds from inflation pressures, higher rates, growing deficits, and elevated oil prices. The predominant tailwind behind the resilient labor market is growing corporate profits and the benefits of substantial AI capex.
Key Takeaways
1. The U.S. economy was stronger in the first half of the year than previously estimated.
Q2 GDP growth was revised to a +2.2% annualized rate from the +1.5% initially reported, while Q1 growth was revised up to +2.5% from +2.1%. Underlying demand was even stronger: a measure of consumer spending and private fixed investment increased at a +4.6% rate in the second quarter, the strongest pace since early 2023. The upward revisions reflected stronger consumer spending and business investment. Implication – The updated figures show that the economy entered the second half with considerably more momentum than the earlier estimates suggested.
2. Strong consumer spending has been one source of that economic strength.
Personal consumption expenditures increased +0.9% in August, with spending growing +0.6% after adjusting for inflation. However, personal income only increased by +0.2%, and after-inflation disposable income remained unchanged. Consumers bridged part of that gap by saving less, with the personal savings rate falling to 4.1% from 4.6% in July. Implication – Consumer spending remains strong despite weak confidence, but August’s gains relied partly on households saving less as spending grew faster than income.
3. AI investment has also contributed to economic growth.
Business investment remained strong in Q2, with continued spending on computing equipment, software, and other intellectual property. Micron’s latest earnings provided a fresh look at the scale of the buildout. Quarterly revenue reached a record $54.2 billion as demand from cloud and data center customers increased sharply, and the company projected roughly $61.5 billion of revenue for the current quarter. Implication – The AI boom is increasingly visible in the broader economy, with spending on the infrastructure needed to build and run AI systems contributing to strong investment growth.
4. Long-term Treasury yields continue to rise, touching their highest levels in more than two decades.
The 10-year Treasury yield rose above 5.30%, while the 30-year yield approached 5.70%. Both yields now sit at their highest levels since 2002. Stronger economic growth helps explain part of the upward pressure, but persistent inflation, heavy government borrowing, and broader global bond-market weakness have also contributed to rising long-term rates. Shorter-term yields were steadier this week, underscoring that the move is about more than expectations for the next Federal Reserve decision. Implication – Rising long-term rates are tightening financial conditions by raising borrowing costs for mortgages, corporate debt, and other parts of the economy.
5. Higher interest rates are weighing on much of the stock market, while strong AI growth is helping the largest technology companies hold up better.
The market-cap-weighted S&P 500 has fallen about -2% from its mid-August high, but its equal-weight counterpart has fallen around -6% over the same period, showing that the typical stock has experienced a more difficult environment than the headline index suggests. Higher bond yields have created a tougher backdrop for many companies, while exceptionally strong earnings and investment tied to AI have continued to support several of the market’s largest technology stocks. Implication – Market leadership has become increasingly concentrated, reflecting both a tougher rate environment for many companies and strong fundamental growth in a small group of technology stocks
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