Summary
The end of a strong Q2 earnings season coincided with a decisively hawkish message from Federal Reserve Chair Warsh at the Jackson Hole Economic Symposium on August 28th: “Here is my standard: We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do. That’s our job.” After the recent downshift in the market pricing of Fed rate hike expectations through 2026, they have reset higher as have Treasury yields (also throw in the brewing U.S.-Canada trade spat for good measure, which has only added to the market risk premium).
Higher Treasury yields typically impact equities via a higher risk-free rate which can reduce the present value of future cash flows and compress equity valuations, all else being equal. They can also tighten financial conditions which dampens risk appetite. However, per our Biweekly Charts in Focus, over the past 20 years, annual changes in Treasury 10-year yields cannot effectively predict YoY changes to the Nasdaq-100. It is the fundamentals such as earnings expectations—measured here by the annual change in Nasdaq-100 NTM consensus EPS—which historically have had greater explanatory power in terms of equity index returns.
The markets and the economy have lived with higher rates in the past, and the Treasury 10-year yield matches up directionally with U.S. nominal GDP growth since 1980. As we’ve discussed before, it is not just the rise in rates but it is also why rates are rising which is important. Our decomposition model of nominal Treasury 10-year yield changes YTD continues to point to it being overwhelmingly driven by the change in real rates as a byproduct of Fed policy repricing amidst a resilient U.S. economy.
Against this backdrop and amidst shifting equity market returns, corporate earnings and revenue estimates remain solid over the next few quarters. But we are watching to see if lower expectations develop into mid-2027. The strong corporate earnings construct is also reflected in U.S. corporate credit spreads which are hovering near 20-year tights. In the very near-term, as the markets push into what has historically been the weakest month for U.S. equity returns (September), equities could remain unsettled amidst the higher rates backdrop, AI capex questions, and ahead of key macro data points that will further inform the September 16th Fed meeting.
