Market Thoughts: The Heat is on!

There’s a growing list of things ruffling the bond market. Bond vigilantes have saddled up. First and foremost because of the war and, by extension, energy markets. For the chartists, run the correlation of spot energy prices to global government bond yields. Mic drop.

Heavier government supply, fiscal laxity and corporate crowding out of new government bond issuance factor in. They’re structural issues that will continue to feed through into inflation and higher-for-longer interest rates. I say that as a pragmatist, not to be alarming.

Each of those issues is particularly challenging for the U.S., Europe and Japan. Where yields go across those major markets, global rates will follow. The same is the case for currency markets. You can clearly see it in dollar strength. A ceasefire in the Gulf would help dial down the heat.

Inflation’s going to be stickier for longer, which keeps a few hikes from the Federal Reserve (Fed) and European Central Bank (ECB) as the base case today, looking into next year. That may change. Markets are pricing in three hikes from the Fed and just under three from the ECB as of this writing.

Global financial conditions have tightened. Given where we are with growth and labor markets (a good place), they’re not restrictive. There’s good and bad news in that observation. Bond vigilantes have made an initial point about inflation, fiscal laxity and monetary policy. They haven’t rioted.

To make an overly simplistic observation about central bank rate hikes, when pushed too far too quickly, over-geared pockets across markets begin to creak. Sometimes break. Think back to the bank runs in 2023, including Signature, Silicon Valley and Silvergate banks.

The root cause was rising interest rates, as the Fed hiked assertively to address inflation. They were behind the curve, late to the game. That’s not the case today. It’s not only about how much tightening, but importantly the pace. Markets can absorb gradual tightening.

There is a great deal of leverage today in public and private markets. A simple case in point, the explosive growth we’ve seen in leveraged ETFs and derivatives trading. That will only add to market volatility if things get bumpier. We’ve seen that happen a few times this year.

The market is doing some of the heavy lifting for central banks. That argues for a bit of patience around monetary policy. A lot of ‘bad vibes’ are priced into bond yields. The near-term outlook for where bond markets go from here is asymmetric. That’s worth bearing in mind.

Bond yields look tempting, but the mark-to-market’s going to be messy. There is bottom fishing going on in government bonds. But the risks swirling around duration leave me cautious. We have an ample reserve of short-duration exposure in multi-asset portfolios. We added to it in pockets over the past month, as fixed income volatility began to kick up.

Along with hawkish central banks, I expect we’ll continue to see analyst forecasts for interest rates move higher. They should. Geopolitical uncertainty, as touched on above, only adding to anxiety. Growth forecasts are in good shape. They too may see revisions lower the longer the war’s drawn out.

Given the sell-off we’ve seen in bonds, at a headline level risk assets appear well-supported. As you dig deeper, the breadth of support across equity and extended credit markets looks more troubling. But for understandable reasons, given what’s happening in bond markets.

Distressed debt issuers are under pressure. Equity market bond proxies—including financials, utilities, small cap stocks, REITs and homebuilders—are as well. Under the equity market index hood, a lot of damage was done. We’re adding to a few of the more hard hit stocks and sectors.

Winners (AI-related names) keep winning on a relative basis. Losers (bond proxies) remain under pressure. The ‘in-betweens’ are treading water. And so it goes, investors await the next leader/laggard rotation. Bond yields will have a lot to do with the timing.

For stocks in the S&P 500, sensitivity to long-duration bonds has increased. We see extremely low realized correlation to history across individual stocks. Also, higher than average dispersion in returns. The equal weighted S&P 500 just hit a one-year low against the cap weight index. There’s a lot going on under the pretense of a ‘calm-water’ market surface.

Stable economic growth supports equity markets. The S&P 500’s de-rated three multiple turns this year. That said, given the rise in rates, equity markets look their most expensive relative to core bonds in the past twenty years. That may continue to weigh on market multiples.

Economic growth is powering earnings. Also, capital investment. With operating leverage at an index level robust, all eyes are on the earnings season kicking off. If multiples are stalled, earnings will remain the driver of equity markets ahead. That’s pretty much been the case all year.

In round numbers, analysts expect earnings for the S&P 500 to grow +25-30% year-over-year (yoy) this quarter. Forecasts for European earnings look to be up +15-20% yoy. Earnings growth is the ‘energizer bunny’ of equity markets. We remain overweight U.S. equity markets, funded from core bonds.

Until we’ve hit a marked inflection lower in projected earnings growth, dip-buyers should remain active. The capex supercycle’s in full swing. That’s something we continue to hear from C-Suite execs. Investors will be listening closely to earnings calls for the drumbeat to continue. The heat is on!

Unless explicitly stated otherwise, all data is sourced from Bloomberg, Finance LP, as of 10/8/26

EPFR fund flows data as of 8/31/26

Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable but should not be assumed to be accurate or complete. The views and strategies described may not be suitable for all investors.