Market summary: The market brushes off higher oil and a Fed rate hike
Equity markets rose modestly in Q3 as strong corporate earnings, continued AI-related capital spending, and evidence of ongoing economic expansion helped offset headwinds from rising oil prices amid renewed conflict between the US and Iran.
Bond yields increased as the US Federal Reserve raised policy rates for the first time since 2023, despite efforts by the US Treasury to support market liquidity through debt buybacks and foreign-exchange intervention. These developments in fixed income remain an important driver for markets in the months ahead.
A constructive growth backdrop, improving labor markets, and persistent inflation increase the likelihood of additional Federal Reserve rate hikes. Globally, mid-cycle economic expansion and low recession risks still support risk assets.
Looking ahead, stubborn inflation, elevated oil prices, and unsustainable sovereign debt may contribute to higher interest-rate volatility.
Index volatility does not tell the whole story: Equity market volatility, as measured by the CBOE Volatility Index (VIX), remained relatively subdued in Q3. Beneath the surface, however, individual stocks experienced wider price swings than broad index performance suggested. Lower correlations across sectors, particularly within traditionally defensive areas of the market, reinforced this pattern. Geopolitical developments, higher interest rates, and differing exposures to AI-related themes contributed to wide performance ranges at the sector and security level.
Commodities led all core asset categories as geopolitical risks intensified and oil prices surged. Higher bond yields pressured fixed income markets and rate-sensitive equities, including real estate and small caps.
Expectations for a resolution to the US–Iran conflict faded during Q3 as tensions escalated and disruptions to shipping through the Strait of Hormuz persisted.
Economy/macro: A variety of business cycle dynamics
The global economy remains in a solid yet unsynchronized expansion as countries continue to face fiscal, monetary, and geopolitical crosscurrents.
Amid the geopolitical uncertainty, global activity remained in expansion throughout Q3, underpinning earnings optimism and upward profit revisions across all major regions.
This resilience was reflected in broad-based improvement in global manufacturing activity and a positive "bullwhip" effect, as new orders rose relative to inventories.
While energy-related disruptions and supply-chain pressures persist, the global economy appears well positioned to weather such challenges.
See our interactive chart presentation for an in-depth analysis.
US mid-cycle expansion continues: The US demonstrated solid mid-cycle dynamics, with economic activity strengthening over the quarter as labor-market conditions improved and manufacturers grew more optimistic amid healthy new-order growth. Leading indicators indicate the US economic expansion remains intact, underpinned by solid demand across the corporate and consumer sectors.
Corporate earnings expectations moved significantly higher for a third consecutive quarter, with the market expecting a nearly 30% growth rate in 2026. Earnings broadened beyond the “Mag 7” this year. The earnings outlook also improved in 2027 and beyond, as the market expects profit margins to remain elevated relative to history—especially among large information technology companies.
The labor market strengthened in 2026, creating over half-a- million jobs over the past year. At the end of Q3, most major indicators we monitor are trending positively, suggesting a broadening employment backdrop.
Watching consumer sentiment and inflation: Consumer sentiment dipped in the quarter as rising gas prices weighed on workers’ purchasing power. Other areas of concern include interest-rate-sensitive sectors, particularly housing.
Inflation remains stubbornly above the Federal Reserve’s 2% target. Goods inflation saw the largest increase year-to-date, fueled by higher oil and tariffs. Service inflation ticked higher as labor markets rebounded and housing inflation slowly drifted lower. The breadth of inflation has increased as a growing number of components of the consumer price index have inflected higher. We expect inflation to remain above target despite the market’s more optimistic outlook of reaching 2% in 2027.
Asset markets: A shift in leadership
The third quarter of 2026 saw a shift in performance patterns. Energy stocks and commodities experienced a strong rebound, helped by higher oil prices, but small caps waned, partly due to higher borrowing costs. Fixed income markets struggled, with most sectors down year-to-date.
Both European and emerging-marking stocks underperformed, although most equity categories remained in positive territory year-to-date.
Equities: By equity style, value stocks (+2.3%) equaled the advance of growth stocks for the quarter, as some investors sought thematic diversification from the US equity market’s largest components. Growth stocks advanced just 0.5%, whereas small caps (-7.2%) and mid caps (-3.0%) declined as policy interest rates rose.
Globally, Japan (+6.0%) led major markets, supported by strong participation in the AI investment cycle, improving fundamentals, and political support for growth. Latin America (+3.9%) and the EMEA region (+2.9%) also rose. Conversely, Europe (-1.6%), a major energy importer, suffered disproportionately from higher oil prices, as well as persistent inflationary pressures that led the European Central Bank to raise interest rates.
Fixed income: Rising longer-term yields negatively affected longer-term fixed income asset classes. Long government & credit (-7.7%), mortgage-backed securities (-4.3%), and emerging-market debt (-3.9%) posted negative returns for the quarter. Only leveraged loans (+1.9%), which feature among the lowest durations in fixed income, posted a gain.
Yields now look historically attractive, however. After almost two decades of bonds providing yields well below their historical averages, the Q3 spike in bond yields pushed investment-grade bond yields nearly into their top quartile of yields over the last three decades. Credit spreads have been relatively well behaved and mostly remain in their lowest quintile relative to history.
Commodities: Commodities (+16.2%) rose more than all equity, bond, and real estate categories during the quarter as energy prices surged.
Multiple dynamics supporting global energy supply faded in Q3 as geopolitical risks intensified. The US approached the limits of its strategic petroleum reserve releases, reducing a key source of support for global oil supply. Meanwhile, a recent uptick in oil inflows could reflect higher Chinese oil demand, possibly reversing a trend that had tempered price pressures earlier in 2026.
Against this backdrop, investors increasingly priced in the risk of prolonged supply disruptions and a tighter global energy balance.
Outlook: Earnings momentum, improving labor dynamics, and a resilient consumer support the fundamental economic backdrop.
The cyclical outlook will depend heavily on the buildout of AI, the pace of adoption, access to funding, and its effects on labor markets and inflation.
The mid-cycle expansion and low recession risks globally support risk assets, but equity market corrections are common especially after periods of strong performance. Diversification in fixed income and inflation-resistant assets remains attractive to hedge risks.