Bonds, banks and the AI boost

Markets spent August recalibrating what “higher for longer” might mean for policy rates and bond yields. Central bank rhetoric hardened across both developed markets and parts of emerging Asia, while stress in long-dated government bonds prompted an unusual intervention by the U.S. Treasury. Although higher yields threatened equity returns, robust earnings from artificial intelligence (AI)-related sectors helped to keep stocks buoyant.

Hawks are back

The Jackson Hole symposium gave U.S. Federal Reserve (Fed) Chair Kevin Warsh a platform to clarify the message from the July Federal Open Market Committee (FOMC) press conference. He sharpened the Fed’s inflation message, stating that it still has work to do to contain price increases in the economy. The speech lifted the odds of a September rate hike to over 60%, while the policy-sensitive two-year Treasury yield rose by 12 basis points (bps) shortly after.

At the July FOMC meeting, three of the 12 members voted to raise interest rates. Since then, some committee members have continued to argue that further tightening is required, while Chair Warsh has said monetary policy is not yet restrictive. The bar for another rate hike appears to be lower heading into the September FOMC meeting. However, a softer inflation report before that meeting may change the market view. It is also not clear just how the Fed views its interaction with markets, specifically whether it expects tighter financial conditions on the expectation of tighter policy to do part of the heavy lifting without having to move rates. Another complication is that while the Fed is independent, a hike before the U.S. midterm elections could trigger a political blowback.

The Reserve Bank of Australia (RBA) kept the cash rate unchanged in August at 4.35%. After 75 bps of tightening earlier in the year, the RBA could add another 25 bps as soon as September. The August decision to hold was unanimous but uneasy, and the board left the door open to further increases.

Since the meeting, incoming economic data has been generally softer, particularly in the housing market. However, household spending has remained resilient on some measures, and July inflation was stronger than expected. Headline inflation fell to 3.5% year-over-year (y/y) but the underlying measure of core inflation remained steady at 3.6% y/y, higher than expected, after a soft June figure. The RBA had indicated that capacity pressures were easing, but perhaps this is happening too slowly for the policy setters. Concern that inflation expectations could become embedded may be enough to prompt another hike.

The hawkish shift extended across Asia. The Bank of Korea delivered a second consecutive quarter-point hike to 3.00% and signalled further tightening this year. The Bangko Sentral ng Pilipinas also raised rates in August, taking its cumulative increase over three meetings to 75 bps and the policy rate to 5.00%. While both banks are hiking, there is a contrasting divide: Korea is tightening from a position of strength, supported by AI-driven growth, while the Philippines is confronting a challenging inflation outlook driven by fuel, food, and wage pressures.

We’ve been expecting you, Mr Bond

The bond market offered a reminder of who is really in charge, as the U.S. Treasury intervened twice in global markets during August to contain or prevent disorderly bond market movements.

In early August, the U.S. Treasury undertook coordinated currency intervention, the first since 1998, to halt the Japanese yen’s steady decline. The currency reached a 40-year low of 164 per U.S. dollar before the intervention, then rising to 157 as the U.S. and Japanese governments stepped in. One possible rationale for the coordinated intervention was to reduce the risk that Japan’s Ministry of Finance would sell part of its large holdings of U.S. Treasury reserves to support the yen, adding pressure to the U.S. Treasury market when long-term yields were already rising.

The Treasury intervened again, this time in the U.S. bond market, as long-dated U.S. yields climbed to their highest level in nearly two decades at 5.31%. The move reflected higher expected policy rates, rising commodity prices and term premia, concerns about U.S. debt and issuance, and growing long-maturity investment-grade issuance from U.S. hyperscalers, which is competing for investor capital. In response, the Treasury doubled liquidity support through bond buybacks in longer-dated tranches, from USD 2billion to USD 4billion.

Both interventions proved temporary. The Japanese yen weakened back to nearly 160 per U.S. dollar, while the 30-year Treasury yield ended August at 5.24%. Interventions can buy time and slow market momentum, but they do not resolve the forces behind a weak currency or lenders’ demand for greater compensation. Without durable policy solutions, the impact of intervention will always be temporary, leaving both the U.S. dollar and the Japanese yen under pressure.

Gold was a beneficiary of these shifting currents. After giving back some of its strong gains earlier in the year, the metal is rising again as the debasement trade re-emerges. The price of gold climbed 9% to USD 4,482 per ounce over August, supported by a weaker U.S. dollar, persistent central-bank demand, and continued risks from the Middle East conflict.

Earnings strength vs breadth

U.S. earnings continue to strengthen. S&P 500 earnings per share (EPS) growth for 2Q26 is on track to reach 38% y/y, with 28% expected for the full calendar year. This would be only the third year of double-digit earnings growth since the 2000s.

Second-quarter earnings strength was concentrated in two themes: AI and oil. Just ten companies accounted for 77% of expected 2Q26 earnings growth. Hyperscaler results were also boosted by large gains on investments in private AI companies. Even excluding those gains, however, 2Q26 EPS growth remained a strong 19%y/y, matching 1Q26.

There was some earnings strength beyond AI and oil. Aerospace and defence, luxury apparel, personal care products and medical equipment also posted strong results. Their influence on the headline S&P 500 is less visible because of their lower index weights and the scale of the AI and energy gains.

The key AI debate remains whether enterprise adoption can keep pace with the revenue expectations embedded in hyperscalers and key input suppliers. Enterprise adoption has been relatively slow because many companies must first upgrade their systems before they can realise the benefits of agentic AI.

Markets tested, not derailed

August showed that markets can absorb higher yields when growth and earnings remain supportive. Central banks across developed and emerging markets signalled that monetary tightening is not finished, yet equities broadly took the news in stride, helped by another strong quarter of AI-related earnings.

The bond market sent a more cautionary signal. Persistent fiscal pressure pushed long-dated yields to multi-decade highs and prompted a policy response, while gold’s advance reflected concern about currency and debt dynamics beneath an otherwise calm surface.

The steady growth outlook and supportive earnings outlook mean leaning towards risk in equities and corporate credit as the preferred approach. However, the rotation beneath the surface in the equity market suggests investors are conscious of the high returns delivered by some segments of the market and need to broaden out risk exposure. 

Global economy

• In the Jackson Hole meeting, Fed Chair Kevin Warsh delivered a hawkish message, stressing that inflation remains the Fed’s immediate priority and that recent declines in headline CPI and PCE do not prove underlying price pressures have eased. Markets raised the implied probability of a September 15–16 rate hike, though the Fed may still struggle to secure a majority after only three of 12 voters backed a hike in July.
• Euro area inflation rose to 2.9% y/y in July from 2.8% in June, with services contributing the most to the annual rate, followed by energy. European Central Bank (ECB) policymakers are reportedly prepared to raise rates in September to contain Iran-war-related inflation effects, though appetite for signaling further tightening appears limited and will likely depend on whether elevated energy prices feed into wider inflation dynamics.
• China’s July activity data weakened further and missed expectations, with industrial output up 4.5%, retail sales rising just 0.6% and January–July fixed asset investment contracting 6.7%, including a 19% decline in property investment. Industrial profits slowed versus the first six months, reflecting weak domestic demand, while the National Bureau of Statistics (NBS) cited operating difficulties amid a complex external environment. CPI declined on lower food prices, the producer price index (PPI) slowed on fading energy costs and soft demand, unemployment ticked higher and house prices fell another 3.4% y/y.
• In Japan, nationwide core CPI rose 1.8% y/y in July, in line with expectations and up from 1.6% previously, marking the highest reading since January but remaining below the BoJ’s 2% target for a seventh straight month. Core inflation excluding fresh food and energy also firmed to 1.9%. The data reinforced expectations that the BoJ may move on rates in September, with pressure to act intensifying as energy prices remain elevated and import costs stay high. A BoJ hike appears already discounted and is not expected to materially affect the broader economy, though small and medium-sized firms may face more pressure as higher borrowing costs feed into supplier output prices. 

Equities

• Global equities advanced in August, with the MSCI World rising 2.4%, and the S&P 500 and Nasdaq both posting gains. AI remained the dominant performance driver, as S&P 500 second quarter earnings surged and strong results from AI-related companies continued to fuel broad risk appetite. Global equity markets rallied through to mid-August, before a late-month selloff driven by rising bond yields and elevated oil prices tempered gains and left the S&P 500 slightly below its record close.
• Asian equities were mixed and highly volatile in August. The MSCI Asia Pacific ex Japan index posted a strong mid-month gain, with South Korea’s KOSPI surging over 10% in the week through August 14 and Taiwan advancing on renewed AI confidence. Both markets reversed sharply on August 18 as rising Treasury yields and the expiry of the U.S.-Iran ceasefire triggered a risk-off episode, before leading U.S. chipmakers’ blowout earnings lifted tech hardware stocks across the region into month-end.
• Australian equities were volatile but resilient in August, with the ASX 200 hitting record highs early over the month before giving back some ground into month-end. Mining led gains on firmer copper prices, while energy outperformed on strong earnings and higher oil prices. Technology recovered late in the month on blowout earnings from a leading U.S. chipmaker, while financials underperformed amid weak mortgage demand and rising RBA rate hike expectations.
• Greater China was volatile and mixed in August. Mainland markets swung sharply around AI and semiconductor themes throughout the month. In Hong Kong, insurer shares declined after China imposed 20% tax on offshore insurance income, while select internet names surprised the market with share placement at significant discounts, dragging the Hang Seng Tech Index down 3.6%. Macro sentiment remained cautious overall, with soft domestic demand and policy uncertainty offsetting support from strong exports and AI infrastructure spending.
• Elsewhere, Southeast Asian markets were mixed, with Singapore and Indonesia as notable bright spots. Singapore’s FSTE Straits Times Index hit record highs after the trade ministry raised its 2026 GDP forecast to 4.5%-5.5%, while a stronger-than-expected GDP growth rate and rotation into cheaper markets sparked rebound in the Jakarta Composite Index (JCI).

Fixed income

• The U.S. Treasury (UST) yield curve steepened in the first half of August, as government bond yields rose globally on a confluence of markets demanding higher term premium, expectation for higher real rates, uncertainty in the Middle East conflict, ongoing concerns over fiscal sustainability and the crowding out effect by AI hyperscalers’ issuances. That said, the yield curve has largely twisted flatter since the Treasury’s buyback announcements and Warsh’s hawkish speech at Jackson Hole. 2-year yields end the month 7 bps higher at 4.34%, while 30-year yields nudged 1 bps lower to 5.24%. Overnight Index Swap (OIS) markets currently price in a 65% implied probability for a rate hike at the September FOMC meeting, with a full hike by 2026-end and another by June 2027.
• Credit spreads were flat for investment grade bonds in August, as increased bond issuance from tech hyperscalers weighed on valuations, despite fundamentals continuing to screen robust for the rest of the credit market. High yields outperformed as supply remains subdued alongside supportive earnings, with spreads tightening by 15 bps. As such, global investment grade and high yield delivered positive performance over the month, up 0.6% and 1%, respectively, in total return terms. 

Alternatives

• According to PitchBook data, the number of global private equity deals in 2Q26 is estimated to have increased to 5,672, up from 5,552 in the last quarter. Momentum on deal value stalled, however, with deal activity estimated to amount to USD 420billion in 2Q26, lower than USD 544billion in the last quarter. Exit activity in global private equity also slowed, with USD 275billion across 948 exits estimated in 2Q26, down from USD 343billion across 1,000 exits in the last quarter.
• As for the U.S. middle market, the J.P. Morgan Private Assets Index-Middle Market returned a total 15.9% on a trailing 12-month basis as of July, with revenue growth, net debt change and multiple expansion attributing to 10.3%, -2.2% and 7.5%, respectively.
• Based on the KBRA DLD Direct Lending index on a par-weighted basis, the trailing 12-month default rate excluding non-accruals rose 80 bps over July to 2.2% due to restructurings with one major issuer. As such, the trailing 12-month default rate including non-accruals nudged down to 3.8%. Yield to maturity rose by 13 bps to 9.27% as of July. 

Other financial assets

• Oil prices moved sharply higher in August as the U.S.–Iran conflict escalated, with renewed attacks on tankers in the Strait of Hormuz and a Houthi strike on a Saudi Arabian refinery further disrupting supply. Prices pulled back late in the month as Iran resumed talks with Oman on reopening the Strait, leaving execution risk around physical flows and diplomatic durability as the central market focus.
• The USD continued its decline in August with the DXY index closed at 99.4, driven by softer U.S. jobs data, mixed inflation readings and the Treasury’s decision to boost buybacks of longer-dated bonds. By contrast, developed market currencies, such as the EUR and GBP, posted their second consecutive monthly gains, while the JPY retraced to above 160 despite prior intervention efforts. The AUD outperformed due to a combination of surging commodity prices, sticky domestic inflation and hawkish central bank policies.

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