What to watch in the week ahead

• The 10-year US Treasury yield reached its highest level since 2007 as the market-implied probability of an October Fed hike rose from 53% to 64% last week. US and Eurozone inflation data will test expectations for further tightening. We believe markets are pricing in more rate hikes than major central banks will ultimately deliver.
• The S&P 500 gained 1.2% last week, finishing within 1% of its record high despite higher yields. The September US employment report and manufacturing survey will test whether growth remains firm without adding to inflation. We expect resilient growth and robust earnings to support further equity gains.
• Rapid early adoption of Meta’s Muse helped fuel enthusiasm for consumer AI agents. OpenAI’s developer conference will give investors a closer look at new tools and what they might enable. We remain constructive on AI while favoring diversified exposure.

Can government bond markets regain their poise?

Government bond yields rose further last week as stronger economic activity and higher energy prices led investors to anticipate faster central-bank tightening. The 10-year US Treasury yield rose nearly 17 basis points to 5.16%, reaching its highest level since 2007, as the market-pricing implied probability of an October Federal Reserve rate hike climbed from 53% to 64%. The 30-year yield also rose nearly 17 basis points, its largest weekly increase since May, to 5.49%, the highest level since 2004. In Europe, the spread between 10-year French and German government bond yields, typically a measure of anxiety in fixed income markets, reached around 110 basis points, its widest since July 2012.

This week's inflation data in both the US and Eurozone will help determine whether such headwinds will persist. Investors will scrutinize Wednesday’s August US personal consumption expenditures release, a key inflation measure, for signs of whether price pressures are spreading beyond energy. September’s Eurozone flash inflation reading will provide a similar test after the prior month's data provided some reassurance that underlying inflation has so far remained under control. A wide range of top officials from the Fed, European Central Bank, and Bank of England are scheduled to speak, and will have the opportunity to respond to recent data and market developments. Contained underlying inflation, particularly if officials push back against expectations for rapid tightening, could help calm bond markets. Firmer readings or more hawkish comments could extend the selloff.

We believe markets are pricing in too much tightening from all three central banks. Our base case is for the Fed to raise rates once more in December before keeping them steady. While higher energy costs may keep headline inflation elevated in the near term, they can also constrain growth by reducing household purchasing power and increasing companies’ costs. We continue to rate fixed income as Attractive, with opportunities emerging across regions and market segments. The recent rise in yields has created tactical opportunities to add medium- to long-duration exposure to high-quality bonds, in our view. Stronger investment grade issuers offer attractive carry across medium maturities, while emerging market bonds offer appealing yields and diversified return potential. We remain more cautious on the longest maturities, and higher-risk credit should remain relatively short-dated.

Can the equity rally continue to withstand higher yields?

Equities showed resilience last week despite the sharp rise in government bond yields. The S&P 500 gained 1.2%, finishing within 1% of its record high, while the MSCI All Country World Index rose 0.9%. Although stronger activity contributed to the bond sell-off, it also pointed to continued demand for companies’ goods and services—a tailwind for equities. The US flash composite purchasing managers’ index rose to 58.4 in September, its strongest reading since July 2021. Eurozone business activity also reached its highest level in almost three and a half years. The equity market’s advance suggests that investors have so far been willing to look past higher discount rates while growth remains firm.

Friday’s September US employment report will provide a further test of that balance. August payrolls rose by 162,000, far above expectations and up from a revised gain of 21,000 in July, suggesting that demand for workers remained firm. Investors will assess whether hiring continues to support household income and consumer spending, without sparking rapid wage growth and adding to inflation. Thursday’s ISM manufacturing survey will provide another check on the strength of demand after eight consecutive months of expansion through August. Its prices component will matter too: Firm activity without another rise in input-cost pressure would be easier for equities to absorb than growth accompanied by a further jump in yields.

Our base case remains that resilient economic growth and robust earnings will support further equity gains over the next six to 12 months. We forecast S&P 500 earnings growth of 25% this year and 14% in 2027. Higher yields are more concerning for equities when growth starts to falter; for now, the US economy remains on solid footing, and we expect a measured tightening cycle to have only a limited effect on activity. A prolonged inflation-driven rise in rates would increase the risks to valuations. We continue to recommend positioning for further equity gains while diversifying and managing concentration risk.

Can AI agents sustain enthusiasm for the AI trade?

There was fresh evidence last week of public enthusiasm for AI services. Meta’s Muse, a consumer agent, recorded more than 2.5 million downloads in its first 13 days and became the most downloaded free app on US Apple iOS and Google Play stores. The resulting positive sentiment helped the tech-heavy Nasdaq reach a record high.Agents that can carry out tasks, rather than only answer questions, could allow AI platforms to earn revenue from transactions as well as subscriptions and advertising.

OpenAI’s developer conference on Tuesday offers the next opportunity to assess how quickly useful applications are developing. Although the a keynote, demonstrations, and technical sessions on its tools. Investors will be looking for evidence that developers can build agents capable of handling more practical tasks. New tools could sustain enthusiasm after Muse’s strong start. The longer-term question is whether wider use can create a clearer link between the substantial investment in computing capacity and future revenue.

We maintain our constructive outlook on the AI trade, supported by rising adoption, potential new sources of revenue, and growing capital spending. Wider use of consumer agents could increase demand for computing power, benefiting high-quality semiconductor and hardware companies. Strong demand does not remove execution risks, however: Delays in bringing data centers online could postpone the revenue expected from that investment. We therefore favor diversified exposure across the AI value chain, including large technology platforms with diversified earnings, rather than relying on the success of any single agent.