The U.S. Federal Reserve took center stage in the third quarter, enacting its first interest rate hike since 2023 to combat a reaccelerating inflation problem weighing on the broader economy. In September, rising energy prices further stoked inflation with Brent crude oil surpassing $100 per barrel, spurred by the Iran-US conflict and related Strait of Hormuz restrictions straining global energy supply. Concurrently, the Federal Reserve’s preferred inflation gauge (Personal Consumption Expenditure Price Index) registered at 3.4% in the August report, well above the Fed’s 2% target.
Yields on longer term bonds also saw a historic climb in 2026, highlighted by the U.S. 10-year Treasury bond rate reaching its highest level since 2002 at 5.3%. Economists point to various causes for the rise in interest rates, including strong economic growth and robust artificial intelligence (AI) capital spending. Nonetheless, higher interest rates also portend negative consequences for parts of the U.S. economy, including the all-important housing market where buyers have been buffeted by increasing mortgage rates.
While bond investments have treaded water year-to-date, stocks have built on recent gains thanks to strong corporate earnings, driven by impressive business momentum in the technology sector. With the third quarter earnings season getting underway, analysts are forecasting 30% profit growth for S&P 500 member companies. If businesses can deliver these strong results, it would mark the third straight quarter of 25% earnings growth for the index – an impressive feat. However, market strength in the areas of cloud computing and data centers has become concentrated in a small group of companies, in turn posing risks for investors since future investment returns on the multi-trillion-dollar AI buildout remain unclear.
Looking ahead, the mid-term elections in November are coming into focus, with the outcomes at the polls sure to affect economic policies relevant to financial markets. Tariff policy, fiscal spending, and military expenditures are high-leverage topics that may be impacted by the upcoming House and Senate votes. Overseas, European and Asian economic resilience will be tested as there is no clear end in sight to the Middle East war and related inflationary pressures. Financial markets will also be pressured by government debt concerns that have been building in developed countries, while the U.S. accrued an additional $1.99 trillion of new debt for the fiscal year ending September 30, 2026. As these liabilities accumulate around the world, fixed income investors will be sensitive to how governments plan to fund on-going deficits, while staying alert to the threat of runaway borrowing and its impact on bond markets.
