Market sentiment has shifted uneasily in recent weeks. The economy remains supported by the AI-driven investment boom. But as demand has stayed surprisingly strong and war continues in the Middle East, inflation fears have also gathered force. And worries that the AI boom could turn to bust made some wary of tech stocks.
By the end of Q3, a global shift to tighter money had begun. Bond prices dropped precipitously. The key 10-year Treasury yield climbed above 5%, at one point reaching its highest level for almost 25 years. Although Treasuries recovered somewhat in October, yields have mostly remained above 5%. Higher long-term risk-free rates are pushing up rates across the economy, notably on mortgages and corporate borrowing. Tech companies, turning increasingly to bond markets to finance extraordinary levels of investment, are competing with governments from the US to Europe and Japan that are seeking to finance rising fiscal deficits.
Tech stocks have underpinned equity market strength to a striking degree this year. That does not make them a one-way bet, as investors are seeing this month. Enthusiasm for AI has generally not remained dimmed for long however. After lagging in August, a broad measure of AI stocks rose 4.6% in September. Indeed, it was only due to rising tech stocks that US equities overall eked out a positive Q3 overall. The S&P rose by a little over 2%, pulled up by a 7% jump in the tech sector over the quarter. In the first three weeks of October, the S&P is slightly negative. The tech component -5% and Nasdaq -3%.
Looking ahead, the pattern of AI stocks versus the rest of the market is likely to continue. Expect uneven strength in concentrated equity markets and continued upward pressure on bond yields.
Strong equity markets help to bolster spending, at least for higher income households and corporations. Tech companies see huge advantages in moving fast to develop AI, building new data centers and looking for ways to innovate to expand compute at lower cost. The promise of big profits to those who “win” the competitive race has made tech borrowers insensitive to higher rates. Bond issuance by “hyperscalers” now accounts for almost 20% of investment-grade borrowing by non-financial corporates, up from 2% in 2025. On the other hand, higher interest costs will increasingly crimp spending by rate-sensitive borrowers, whether households or “ordinary” corporates. Already, the housing market is showing signs of stress as homeowners are “locked in” to existing low mortgage rates and new buyers are put off by mortgage rates over 7%, compared to 3% or even less just a few years ago. The particulars of US housing finance make this a drag on demand unlike in other countries where rates vary more over the life of a loan, and borrowers may take a mortgage with them when they move. Commercial property owners also face refinancing pressure, with $875 billion of commercial and multifamily mortgages scheduled to mature in 2026, according to the Mortgage Bankers Association. Higher borrowing costs and, in some cases, lower property values can leave owners unable to refinance the full amount owed, requiring additional equity, loan extensions or asset sales.
In October, pressures on bond yields remained elevated, along the curve in the US and worsened in the heart of Europe. In France, growing concern about political and fiscal fragility sent government borrowing rates shooting up. The traditional gap between German and French bonds widened substantially in Q3. In October, political strains exploded onto the streets with riots in Paris and elsewhere. Investors ran for cover and the 10-year yield climbed above 5%. This is in the context of monetary tightening by the ECB. The central bank raised policy rates again in September, following a 25 basis point increase in June.
Voters elsewhere, and not just in France and the US, seem disillusioned with leaders. In Germany, Chancellor Merz’ party suffered humiliating defeats at the hands of a formerly fringe right wing party in regional elections in Q3. In Brazil’s second round President elections this weekend, President Luis Inacio “Lula” da Silva is fighting against the odds for his political life. Pulling back, it is clear that as long as the US economy continues to create jobs and investment opportunities, investors will be rewarded. What is notable today is that this prospect depends increasingly on AI-related developments. Other factors, notably tightening financial conditions and political discord, present risks.
The IMF now projects global growth at a steady 3.1%, unchanged from six months ago though their record on forecasting has not always been good. The US and global economy have shown remarkable strength over the past year in the face of geopolitical upheaval, higher tariffs and – most importantly – a severe energy shock from conflict in the Middle East. But, global dependence on a single driver of growth is risky. That is particularly true in the context of political divisions and global discord. These have, in turn, led to economic pressures, in the form of inflation and rising fiscal deficits.
Against this backdrop, RockCreek sees three themes going into the end of the year:
AI will continue to be the main driver in the real economy and in markets. The promise of AI is enormous, although the long-term impact on productivity and growth is still highly uncertain. Estimates from analysts vary widely, depending on how quickly technology companies develop profitable use cases, and how successfully societies, businesses and workers adapt and adopt new methods. In the meantime, cyber issues and bumps in the road may cause some companies to fail and others to underperform. Investors and policymakers need to remain flexible and watch out, in particular, for excess leverage that makes companies vulnerable to rate rises.
Higher interest rates are here to stay. Their impact has yet to feed through to the economy. With no quick end in sight to the Iran war, central bankers are accepting that the fight against inflation needs to ramp up. In the US, Federal Reserve Chair Kevin Warsh, still relatively new to his job, has said that he does not believe in forward guidance nor in reacting to single data points. But his focus in public remarks on the importance of price stability together with commentary from key colleagues have clearly signaled that rates are heading higher. The Fed will not rush, after a first 25 basis point move in September. And it will watch for trends in inflation and job growth. That enables Chair Warsh to avoid an October rise in rates at next week’s policy meeting, despite recent disappointing inflation numbers for consumer and producer prices in September. But markets are right to expect tightening to resume in December.
Geopolitics – and domestic political divisions – are clouding the outlook. Inflation and apparently unconstrained fiscal borrowing are the two key risk factors for the US economy. Both feed into higher interest rates which, if sustained, will dampen demand – even in the face of AI enthusiasm. As pointed out nicely in this WSJ piece by Greg Ip: “Yes, the Fed can kill the ai boom.” Sticky inflation can be traced directly to geopolitics. The war launched by Israel and the US against Iran in February did not have the immediate impact on energy prices that many feared. This has now changed. In Q3 the oil price climbed back above $100 a barrel as hopes for a resolution to the war faded and the conflict widened to include Houthi attacks from Yemen on Saudi Arabia. By October 23, the price of Brent crude reached $117/bbl – a post conflict high, some 60% above its pre-war level.
In an attempt to bring down politically sensitive diesel prices, President Trump has collaborated with Russia President Putin, worsening US relations with both Ukraine and Europe. These tensions, and the risk of prolonged conflict, raise uncertainty and dampen “animal spirits.” At the same time, as pollsters report dismal approval ratings for President Trump going into the mid-term elections, the White House has offered new spending and tax cuts to mollify voters. Congressional approval of these measures will not happen. But nor can investors expect a serious attempt to bring down government borrowing with a divided government likely from next January.
Read the full RockCreek Q3 2026 Commentary Letter
