Q3 2026 Review: Resilience at a Higher Price

The third quarter was shaped by the return of energy-driven inflation and a sharp rise in global interest rates. Middle East tensions returned to the foreground, pushing Brent crude oil above $100 per barrel and renewing concerns around inflation and energy supply. The rise in oil occurred against a backdrop of resilient economic activity and generally constructive corporate earnings. This combination proved important. Growth remained firm enough that central banks had less scope to look through the inflationary effects of the shock, even as uneven labor data and continued housing weakness pointed to greater pressure in some areas of the economy. After holding rates in July, the Federal Reserve raised its policy rate by 25 basis points in September. The European Central Bank and Bank of Japan also adjusted policy rates higher during the month, while the Bank of England remained on hold with a divided vote.

Interest rate markets absorbed the greatest adjustment. The 10-year Treasury yield rose more than 80 basis points to 5.29%, while sovereign yields also moved materially higher in Europe, the U.K. and Japan. Most of the increase in the U.S. 10-year yield came through higher real yields rather than longer term inflation expectations. The adjustment therefore extended beyond higher near-term inflation concerns. Rising real yields increased discount rates across markets, placing greater pressure on longer duration and financing sensitive assets.

Equities were comparatively resilient, although headline returns concealed a more difficult market beneath the surface. The S&P 500 Index gained approximately 2%, supported by solid underlying earnings growth and continued investment in artificial intelligence infrastructure. Energy benefited directly from higher oil prices, healthcare provided defensive leadership and selected large technology companies continued to deliver strong results. Yet the advance was far from broad. Smaller companies and more rate sensitive areas of the market fared considerably worse, leaving the advance dependent on a narrower group of large-cap leaders.

Credit markets and real assets showed a similar divide. Investment grade credit spreads widened only modestly, while high yield spreads moved more noticeably higher as all-in borrowing costs increased. Natural resource equities benefited from the commodity backdrop, but global real estate and listed infrastructure declined as the rise in yields outweighed the support from inflation-linked revenues. The U.S. dollar finished little changed, masking more notable moves in individual currencies, while gold ended modestly higher despite the sharp increase in real yields.

By quarter-end, the main question had shifted. Investors were no longer asking only whether the energy shock would fade, but whether earnings and economic growth could remain resilient as the cost of capital moved higher.

Energy markets became a central macro force once again. Brent crude oil rose roughly 42%, moving from the low $70s to above $100 per barrel as Middle East tensions and concerns around supply routes intensified. The pressure extended into refined products, with U.S. diesel and European gasoil prices rising relatively more than crude and U.S. distillate inventories remaining below seasonal norms. Higher energy costs added to near-term inflation pressure, complicating the outlook for consumers, companies and central banks.

Policy expectations followed a round trip during the quarter. Softer labor data and subdued July core inflation initially raised the prospect of a more accommodative Federal Reserve path. That move reversed as energy prices remained elevated, August inflation strengthened and economic activity continued to hold up. The Federal Reserve, European Central Bank and Bank of Japan adjusted their policy rates higher. The Bank of England remained on hold, although three policymakers supported an increase.

The rise in Treasury yields was not simply an inflation story. The 10-year Treasury yield rose more than 80 basis points during the quarter, with the matching real yield accounting for approximately 82% of the increase. The result was a broader increase in the real hurdle rate across markets, placing pressure on government bonds and rate sensitive assets even as economic activity remained resilient. Treasury volatility also increased as expectations for near-term rate relief faded.

Artificial intelligence investment remained an important source of economic and earnings support. Cloud demand and large technology backlogs supported continued expansion in data center capacity, even as borrowing costs increased. However, the investment cycle remained highly capital intensive. Across the technology sector, earnings continued to rise while free cash flow yield declined, increasing the importance of future cash generation in validating the scale of investment and supporting valuations.

Treasury yields rose sharply across the curve as resilient economic activity, higher energy prices and a recalibration of policy expectations reduced the prospect of near-term rate relief. The 2-year yield increased 71 basis points (bps) to 4.89%, while the 10-year yield rose 82 bps to 5.29%. Higher real yields accounted for most of the 10-year move, while breakeven inflation increased more modestly. This left the 2- to 10-year curve modestly steeper, while the curve flattened beyond the 5-year maturity.

Investment grade (IG) credit spreads widened 6 bps to 0.75%, while high yield (HY) spreads increased 41 bps to 3.11%. Higher Treasury yields were the primary headwind for longer duration and higher quality bonds. HY faced additional pressure from wider spreads, although its higher starting income and shorter duration provided some cushion. Credit markets remained orderly overall, but the greater weakness in lower-quality segments reflected increasing differentiation as all-in borrowing costs moved higher.

Global equities finished modestly higher, led by the U.S. Developed ex-U.S. equities posted a smaller gain, while emerging markets declined modestly amid considerable country level dispersion. Within the U.S., large-cap equities remained positive, supported by energy, healthcare and select technology companies, while smaller companies declined. With fewer than 40% of S&P 500 Index constituents posting positive quarterly returns, headline performance remained increasingly dependent on a narrower group of market leaders.

Real assets displayed significant dispersion. Natural resource equities benefited from higher energy and industrial metal prices, while global real estate and listed infrastructure declined. Higher commodity prices supported natural resource equities but also added to inflation pressure, while rising yields weighed on real assets with greater financing needs and longer duration cash flows. Gold finished modestly higher as geopolitical uncertainty and inflation concerns were partly offset by the rise in real yields.