The five-week losing streak is over. The S&P 500 surged 3.4% this week to close at 6,582.69 on Thursday—the last trading day before Good Friday—snapping what had become the longest consecutive weekly decline since the 2022 bear market. The Dow rose 3.0% to 46,504. The Nasdaq led with 4.4%. The Russell 2000 gained 3.3%, putting small caps firmly into positive territory year-to-date and continuing their relative outperformance over large caps. But before anyone declares the all-clear, understand what drove this rally: a single rumor. On Wednesday, Trump told reporters the Iran conflict would end “within weeks.” Markets ripped. Then on Thursday he walked it back, threatening energy infrastructure strikes after April 6. Markets gave back half the gains. This is not a durable bottom. This is a market trading one headline at a time with one eye on the calendar.

The sector divergence widened further into absurdity. XLE is now up nearly 38% year-to-date with a record 14-week winning streak—though it actually fell 3.9% on Thursday as WTI surged 11.4% in a single session. Read that again: the energy ETF fell on the day oil had its largest single-day dollar gain since the April 2020 Covid rebound. The explanation is positioning—traders taking profits into a $111 WTI print that screams “peak fear.” IGV remains down 24.5% year-to-date. The 62-point spread between the best and worst sectors is no longer an anomaly. It’s a regime. Consumer discretionary got a brief reprieve but Tesla fell another 5% on Thursday. The VIX dropped to 23.87 from 31.05 the prior week—the largest single-week VIX decline of the year—but still sits well above the 15–18 range that defined calm in 2024.

The macro data was a study in contradiction. March nonfarm payrolls shocked at +178,000 versus the +59,000 consensus—released on Good Friday while markets were closed, meaning equities will digest this number Monday. ISM Manufacturing came in at 52.7, expanding for a third consecutive month, but Prices Paid surged to 78.3—the highest since June 2022—confirming what every consumer already knows: oil is flowing through to everything. Initial claims at 202,000 hit a near two-year low. The 10-year Treasury jumped to 4.37% in after-hours trading Friday on the jobs beat. The bond market is now telling you what the equity market refuses to accept: rate cuts are not coming. Betting markets give a 92% probability the Fed holds all year. The word “stagflation” keeps getting thrown around. I’d call it something more specific: a labor market that won’t crack and an inflation impulse that won’t quit, all while the geopolitical risk premium expands by the hour.

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Five consecutive weekly losses. The worst monthly decline in the S&P 500 since 2022. And a VIX that just closed above 31 for the first time since the initial Iran shock. If you’re looking for a bottom in this market, the tape is telling you we haven’t found one yet. The S&P 500 closed the week at 6,368.85, down 3.42% on the week and 6.74% year-to-date. Three out of four stocks in the index fell on Friday alone. The Dow entered formal correction territory—down more than 10% from its February record high—and joined the Nasdaq in what is now a broad-based, multi-week liquidation. The Russell 2000, interestingly, posted a mild gain of 0.36% on the week, making small caps the relative outperformer for the first time in three weeks. But let’s not call that a rotation. IWM is still down 2.28% year-to-date and 10.5% from its January high. This is a market where the best you can say about small caps is they fell less.

The sector story is becoming cartoonishly divergent. Energy, measured by XLE, is now up 37% year-to-date. Software, measured by IGV, is down 25%. That is a 62-percentage-point spread between the best and worst performing sectors in the U.S. market. I don’t think investors fully appreciate how extreme that is. IGV fell another 7.35% this week alone—the worst weekly performance of the month—and is now nearly 35% below its 52-week high. Meanwhile, XLE hit a new year-to-date high at $62.79, gaining 5.48% on the week. Consumer discretionary was the worst broad sector, down 2.89% on Friday as cruise lines, restaurants, and retail got hammered by gasoline-price anxiety. Amazon and Meta each fell 4% on Friday. The VIX closed at 31.05, up from 26.78 the prior week. What’s notable is the VIX “stair-stepped” higher even on days when stocks rallied, indicating persistent elevated demand for hedges regardless of direction.

The macro data confirmed the uncomfortable picture. The University of Michigan consumer sentiment final reading for March came in at 53.3, below both the preliminary estimate of 55.5 and February’s 56.6. One-year inflation expectations surged to 3.8%—up 34% from the prior month’s 3.4%. This is the kind of expectations unanchoring that keeps the Fed awake at night. Vice Chair Jefferson acknowledged the dilemma in his March 26 speech: “I confront an outlook where there is downside risk to the labor market and upside risk to inflation.” He estimated February core PCE at 3.0%—“little progress in lowering core inflation over the past year.” Governor Barr echoed the same message. The April FOMC hold probability stands at 94.8%. Betting markets now give a 26-to-41% chance of a rate hike in 2026. Q4 GDP was revised down to 0.7% from 1.4%. The polite word is “stagflation.” The honest word is “trapped.”

European markets whipsawed all week on conflicting Iran signals. The STOXX 600 managed a tiny +0.35% gain, but that number masks violent daily swings—up 1.3% Wednesday on de-escalation hopes, down 1.2% Thursday after Lagarde warned markets were “too optimistic,” and down nearly 1% Friday on the U.S. selloff. The DAX closed at 22,300, roughly 12% below its pre-war February high. The FTSE 100 briefly reclaimed 10,000 mid-week before giving it back, closing at 9,967. ECB President Lagarde’s March 25 speech at the ECB Watchers Conference was the week’s most important central bank communication. She called Iran “a real shock” and outlined a three-principle framework for responding to energy shocks. The key signal: J.P. Morgan and Barclays now forecast up to three ECB rate hikes in 2026; Goldman Sachs expects two, in April and June. The ECB went from a cutting cycle to a potential hiking cycle in less than a month. European natural gas prices are up 89% since February 28. The OECD cut the eurozone GDP forecast to 0.8% from 1.2%.

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The Great Rotation is dead. Or at least it’s on life support. The Russell 2000 was up 8.9% year-to-date as of March 11. As I write this nine days later, it’s down 0.41% on the year. That’s a 9.3-percentage-point drawdown in less than two weeks. The S&P 500 is at roughly 6,583, down 3.49% year-to-date and sitting at four-month lows. Small caps, mid caps, micro caps—everything that was leading the market in early March has been destroyed by the combination of triple-digit Brent crude, a scorching PPI print, and a Fed that is now openly discussing a rate hike. The energy sector is the sole winner, up 34% year-to-date. Software, measured by IGV, is down 20%. The VIX spiked back to 26.5 after briefly dipping to 22.45 on Tuesday’s relief rally. The pattern this week was textbook: hope on Monday, reality on Wednesday.

Let me walk through the macro data because it was genuinely ugly. The February PPI, delayed by the government shutdown, finally dropped on March 18—the same day as the FOMC decision. Headline PPI came in at 0.7% month-over-month, more than double the 0.3% consensus. Year-over-year headline PPI hit 3.4%, a 13-month high. Core PPI was 0.5% month-over-month and 3.9% year-over-year, the hottest in 13 months and the fourth consecutive hot print. Pipeline prices, measured by Stage 1 intermediate demand, are running at 5.3% year-over-year, the worst since December 2022. This is not transitory. This is inflation re-accelerating in the parts of the supply chain that take months to filter through to consumers. Hours later, the Fed held at 3.50–3.75% in an 11-1 vote, with Miran dissenting for a cut. The dot plot still shows one cut in 2026, but seven of nineteen officials now see zero cuts, up from six in December. Powell raised the core PCE forecast to 2.7% from 2.5% and admitted the committee discussed a potential rate hike at the April meeting. He rejected the stagflation label, but then said the Fed is “in a difficult situation” with inflation progress “not as much as hoped.” That’s stagflation with a press-conference smile.

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LEADERS: ENERGY DOMINANCE, DEFENSIVE ROTATION, AND A LUMBER COMEBACK NOBODY SAW COMING

Energy (XLE) – South Pars Changed Everything

Energy’s dominance reached a new level this week after Israel struck Iran’s South Pars gas field — the world’s largest — on March 19, and Iran retaliated by hitting Qatar’s LNG facilities, knocking out an estimated 17% of global LNG export capacity for what analysts expect will be a 3–5 year repair timeline. The XLE/SPY ratio surged another leg higher and is now up a staggering 35.6% over three months, the most extreme relative energy move since the Russia-Ukraine shock of early 2022. Brent crude spiked to $119 intraday on March 19 before pulling back as a late-session geopolitical headline triggered a reversal; WTI hit approximately $98. Iran is now developing a “selective” vetting system for Strait of Hormuz transit, with traffic down 95% and only India, Pakistan, China, and Iraq actively negotiating passage. The FOMC held rates at 3.50–3.75% on March 18 with an 11–1 vote, acknowledging the impossible bind: oil-driven inflation running hot while the economy decelerates. Energy isn’t just a trade anymore — it’s the axis around which every other asset class is rotating. With Brent still above $110 and no Hormuz resolution in sight, the XLE/SPY ratio could have substantially more room to run.

Utilities (XLU) – The Only Shelter That’s Actually Working

Utilities extended their remarkable 2026 run with the XLU/SPY ratio climbing another 11.3% over three months, making this the most sustained period of utility outperformance since the 2022 bear market. In a week where the S&P 500 fell to fresh 2026 lows at 659.80 on March 19 — down approximately 0.4% for the week through Thursday — utilities continued to attract capital as the ultimate defensive allocation. The AI data center demand narrative provides a rare secular growth tailwind for a traditionally boring sector, but make no mistake: this is primarily a fear trade. The FOMC’s dot plot showed 14 of 19 officials expecting zero or one rate cut in 2026, with the median at just one cut, and Waller — who had been a reliable dove — flipped to hold. That hawkish repricing should theoretically hurt rate-sensitive utilities, but the risk-off bid is overwhelming any yield sensitivity. When oil spikes to $119 and a major gas field gets bombed, investors aren’t doing duration math — they’re reaching for the safest equity exposure available.

Treasuries (GOVT) – The Flight to Quality Deepens

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A week ago I said the rotation was real. It’s more than real now—it’s accelerating in a way that’s forcing even the most stubborn large-cap bulls to pay attention. The Russell 2000 is up 8.9% year-to-date through March 11. The equal-weight S&P 500 is positive on the year by several percentage points. Meanwhile, the cap-weighted S&P 500 sits at 6,672.62 as of Wednesday’s close, down 2.53% on the year. That’s a spread of more than 11 percentage points between the Russell 2000 and the S&P 500, and it’s happening while the VIX is at 27.85 after spiking to 35.3 intraday on Monday. This is not a calm, orderly rotation. This is a market that’s simultaneously pricing in a regime change in equity leadership and a geopolitical crisis that has no clear resolution.

The sector story is equally dramatic. The Energy Select Sector SPDR is up roughly 27% year-to-date, hitting fresh 52-week highs almost daily as Brent crude trades above $100 a barrel for the first time since 2022. WTI is at roughly $96. The software sub-sector of the S&P 500, measured by the IGV ETF, is down 19.5% year-to-date. That’s a nearly 47-percentage-point divergence between the best and worst-performing sectors. I’ve been in this business a long time, and I cannot recall a YTD sector spread this extreme by mid-March. February CPI came in at 2.4% year-over-year on March 11, largely in line with expectations. But the real inflation story is in the ISM Manufacturing Prices Paid index at 70.5%, the highest since June 2022, and that reading was taken before Brent broke through $100. The February PPI release has been delayed to March 18 due to the government shutdown—the same day as the FOMC decision. The Fed is boxed in. CME FedWatch shows an overwhelming probability of a hold at the March 18 meeting. The dot plot update will be the real event. If the median dot shifts higher, that’s the Fed admitting the stagflation scenario is becoming baseline.

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Two days ago I wrote about the small-cap rotation being real. It still is, but the market just threw a curveball that complicates the story considerably. The Russell Microcap Index remains up roughly 8% year-to-date. The S&P 400 is up about 5.7%. The Russell 2000 is holding a 4.2% gain. Meanwhile, the S&P 500 is essentially flat on the year at − 0.22%. That relative outperformance in smaller names has not been erased. But the Iran conflict and today’s disastrous jobs report have injected a level of uncertainty that could either accelerate or completely derail the rotation depending on what the Fed does next.

Let me start with the number that matters most right now. February nonfarm payrolls came in at negative 92,000. Not positive 50,000, which is what the consensus was. Not even zero. Negative 92,000. And if that’s not enough, December was revised down to negative 17,000 from an already-weak 48,000. January was revised down 4,000 to 126,000. The combined revision is negative 69,000 jobs. The unemployment rate ticked up to 4.4% from 4.3%, and average hourly earnings came in hot at 3.8% year-over-year. Health care lost 28,000 jobs on strike activity. Federal government shed another 10,000. This is a labor market that is cracking in real time.

Now layer in the oil picture. WTI crude is at $80 per barrel as I write this, up over 20% in a single week since the U.S.-Israel strikes on Iran began. Brent is above $84. The Strait of Hormuz has effectively been closed for six days, which accounts for roughly 20% of the world’s oil and gas supply. The ISM Manufacturing Prices Paid index hit 70.5% in February, the highest since June 2022, and that was before the latest oil spike fully filtered through. Core PCE was already running at 3.0% in December. The energy sector is up 26% year-to-date while the software sub-sector of the S&P 500 is down roughly 17%. The divergence is breathtaking. And it puts the Fed in an impossible position. You cannot cut into rising inflation. You cannot hike into a labor market that just printed a negative payroll number. This is what stagflation looks like in practice, and it’s why the market has pushed the next expected rate cut all the way out to September.

Despite what has been an awful week for risk assets globally, European equities are still outperforming the S&P 500 by 300 to 500 basis points on the year. The STOXX 600 is up about 1.4% year-to-date even after falling nearly 5% this week, its worst weekly decline since April 2025. To put that in context, the STOXX 600 hit an all-time high of 634 on February 27, the day before the Iran strikes began. Europe has given back the late-February surge but the structural outperformance story remains intact. Germany’s €500 billion infrastructure fund is now into its implementation phase, with defense spending at roughly €108 billion in 2026, the highest since the Cold War ended. Goldman Sachs is projecting 1.1% GDP growth for Germany this year, which doesn’t sound like much until you remember the country had six consecutive years of stagnation. The ECB has held at 2.0% for five straight meetings and the March 19 decision is a 99% probability hold. Eurozone headline inflation ticked up to 1.9% in February from 1.7% in January, and the Iran oil shock has made any near-term cut a non-starter.

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• U.S. labor data remain low-fire, but survey growth indicators are cooling toward a ~1.5% annualized pace.¹ ²

• FOMC minutes reinforced a “higher for longer unless inflation reasserts disinflation” stance, with liquidity mechanics adding a subtle tightening bias.³

• Treasury yields drifted modestly lower across the curve, which remains positively sloped and not recessionary.⁴

• Equity index stability masks weak breadth and sharp dispersion within technology, particularly between semiconductors and software.⁵

• High-yield credit spreads remain near cycle tights, signaling risk repricing without systemic stress.⁶

Late-Cycle Macro With a Data and Policy Uncertainty Overlay

The defining feature of the Feb. 18–25 window was not a single outsized data surprise, but confirmation of a late-cycle configuration: labor markets remain resilient, growth is cooling at the margin, and policy uncertainty—particularly around trade—is injecting volatility into cross-asset risk premia.

Weekly initial jobless claims fell to 206,000 for the week ending Feb. 14, underscoring that layoffs remain subdued. Continuing claims rose to roughly 1.869 million, suggesting that while separations are limited, job-finding is becoming incrementally more difficult.¹ The signal is not labor stress, but labor normalization.

Forward-looking growth data tell a similar story. The February flash S&P Global composite PMI eased to 52.3 from 53.0, still expansionary but marking the slowest pace in roughly ten months. Survey-based GDP mapping implied growth closer to 1.5% annualized early in the year, down from the stronger late-2025 cadence.² Employment components hovered near stagnation. The expansion continues—but with diminishing momentum.

Inflation did not deliver a fresh catalyst during the week. Instead, the January FOMC minutes sharpened the Fed’s reaction function. Policymakers emphasized that inflation remains “somewhat elevated” and that further easing would require clearer evidence that price pressures are sustainably converging toward 2%.³ The Committee also referenced market pricing for one to two cuts in 2026, underscoring that policy is not on a preset path.

Importantly, the minutes highlighted liquidity mechanics that can tighten or ease conditions without a change in the policy rate. Reserve management purchases, Treasury General Account flows, and tax receipts were discussed as endogenous drivers of reserve levels.³ In an environment where reserve scarcity could re-emerge, these balance-sheet dynamics matter for money markets and front-end stability.

Macro uncertainty is also literal. The Chicago Fed’s CFNAI publication process has flagged delays stemming from federal shutdown-related disruptions and delayed statistical releases.⁷ The FOMC minutes similarly acknowledged data delays as a forecasting challenge.³ This is a subtle but material shift: uncertainty is no longer purely economic—it is embedded in the data pipeline itself.

Overlaying this backdrop is policy volatility. On Feb. 20, the U.S. Supreme Court struck down emergency tariffs, prompting the administration to signal new levies under alternate legal authority.⁸ The macro transmission channel here is uncertainty rather than immediate price effects. Rapid shifts in trade policy elevate risk premia across equities, credit, and FX—even absent a deterioration in hard data.

In short, growth is cooling but intact, inflation remains a constraint, and policy volatility has become the dominant shock variable.

The Rates Transmission: Mild Easing, No Recession Signal

Rates markets translated this environment into modest duration support but no recession warning.

Between Feb. 18 and the latest H.15 data available during the week (through Feb. 23), the 10-year Treasury yield declined from 4.09% to 4.03%, while the 2-year fell from 3.47% to 3.43%. The curve remained positively sloped, with the 10-year minus 2-year spread narrowing only slightly.⁴ This is not inversion; it is mild flattening within an upward-sloping structure.

Real yields also eased. The 10-year TIPS yield declined from 1.80% to 1.77%.⁴ That incremental decline supports duration-sensitive equities, but it does not suggest a collapse in real-rate expectations. Markets are pricing moderation—not contraction.

Fed communication reinforced this equilibrium. Governor Christopher Waller indicated he could support holding rates steady at the March meeting if incoming labor data confirm improved momentum.⁹ That conditional stance keeps front-end expectations tightly linked to labor confirmation rather than preemptive easing.

The curve’s message is therefore consistent: growth is decelerating, but not rolling over. Inflation is moderating, but not definitively conquered. The Fed is patient, and duration is drifting lower without signaling recession.

This rates backdrop matters because it forms the discount-rate anchor for equities. With real yields stable to slightly lower and no acute credit stress, equity volatility must be interpreted through the lens of dispersion rather than systemic repricing.

Equity Dispersion and Credit Containment Define the Regime

U.S. equities exhibited two simultaneous truths during the window. Index-level resilience persisted, but participation narrowed.

From Feb. 18 to Feb. 24 closes, the S&P 500 rose modestly, and the Nasdaq gained, while the Dow and Russell 2000 declined.⁵ This divergence signals that headline stability masks underlying concentration.

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• January payrolls rose 130,000 and unemployment dipped to 4.3%, reinforcing a growth floor rather than signaling labor stress.¹

• CPI cooled to 2.4% year over year, reopening the path to potential mid-year easing without validating aggressive near-term cuts.²

• The Treasury curve flattened modestly as long-end yields declined, with the 10-year falling 13 basis points over the week.³

• High-yield spreads widened only slightly, suggesting repricing rather than systemic stress.⁴

• The dollar weakened on the week as rate futures increased the probability of a June cut.⁵

• The yen posted its strongest weekly gain in roughly a year amid renewed tightening expectations in Japan.⁶

The U.S.: A Growth Floor with Cooling Inflation

The macro sequence this week mattered more than the absolute numbers. Labor came first. January nonfarm payrolls rose by 130,000, while the unemployment rate edged down to 4.3%.¹ Wage growth remained firm at 0.4% month over month and 4.2% year over year, with the workweek ticking up to 34.5 hours.¹ Initial jobless claims declined to 227,000 for the week ended February 7, reinforcing the view that layoffs remain contained.⁷

The signal was clear: the U.S. economy is not breaking. It is slowing at the margin, but it is not rolling over.

Consumption, however, showed signs of fatigue. December retail sales were unexpectedly flat, with the Census Bureau describing activity as “virtually unchanged” from November.⁸ That nuance matters. The labor market may be stable, yet spending momentum is no longer accelerating.

Inflation then shifted the narrative. January CPI rose 0.2% on the month and cooled to 2.4% year over year.² Core CPI increased 0.3% month over month and 2.5% year over year.² Gasoline prices fell 3.2%, while several service categories reflected early-year price adjustments.⁹

The takeaway is not that inflation has vanished. Core remains sticky enough to prevent an immediate easing cycle. Yet the disinflation trend resumed. That was enough to revive the mid-year rate-cut conversation without forcing the Federal Reserve’s hand.

Markets translated the sequence into duration demand. From February 6 to February 12, the 10-year Treasury yield declined from 4.22% to 4.09%, while the 30-year fell from 4.85% to 4.72%.³ The 2-year eased modestly, producing a flattening in the 10-year minus 2-year spread.³

Rate futures responded quickly after CPI, increasing the implied probability of a June cut and adding easing expectations into 2026.⁵

Credit markets did not flash stress. The ICE BofA U.S. High Yield option-adjusted spread widened slightly from 2.87% to 2.92%.⁴ That move reflects risk repricing rather than funding pressure.

Equities behaved like a market still sensitive to rate volatility and crowded positioning. A sharp growth-led selloff midweek tied to AI-related positioning concerns was only partially repaired by Friday’s inflation relief.¹⁰ Dispersion remained elevated, with internal volatility masking headline index stagnation.¹¹

Liquidity plumbing also remained in focus. The New York Fed indicated that elevated reserve-management purchases of Treasury bills would continue into mid-April, framing the activity as operational rather than stimulative.¹² Meanwhile, the Treasury General Account remained elevated on a weekly basis, leaving near-term liquidity sensitive to bill issuance and tax flows.¹³

The dollar’s weekly decline aligned with the shift in rate expectations. Even as it stabilized into Friday, the broader move reflected markets rotating away from “higher for longer” protection.¹⁴ U.S. policy commentary describing the dollar as closer to a “more natural” trade level added to that tone.¹⁵

Developed Markets: Policy Divergence Reawakens

Europe’s story was more narrative than numeric. An ECB policymaker emphasized that Europe should prepare for a larger safe-haven role globally, highlighting the importance of liquidity backstops and institutional resilience.¹⁶ The euro held firm on the week, consistent with a softer dollar backdrop.¹⁴

The U.K. remains constrained by soft growth and persistent underlying inflation. Public reports showed marginal late-year growth, while the Bank of England’s chief economist emphasized that underlying inflation remains around 2.5% and policy must stay restrictive long enough to complete disinflation.¹⁷ Sterling traded within a tight range, reflecting cross-currents between U.S. repricing and domestic caution.¹⁸

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• January payrolls rose 130,000 and unemployment dipped to 4.3%, reinforcing a resilient labor floor.¹

• CPI cooled to 2.4% year over year, reopening the path to mid-year easing.²

• The 10-year Treasury yield fell from 4.22% to 4.09% over the week, with curve flattening at the margin.³

• High-yield spreads widened only slightly, signaling repricing rather than systemic stress.⁴

• The dollar declined on the week, while the yen posted its strongest weekly gain in roughly a year.⁵

United States: Resilient Labor, Softer Inflation

The week’s macro sequence mattered more than the individual releases. January nonfarm payrolls increased by 130,000, and the unemployment rate edged down to 4.3%.¹ Wage growth remained firm at 0.4% month over month and 4.2% year over year, while the average workweek ticked up to 34.5 hours.¹ That combination does not describe an economy sliding toward recession. It describes an expansion that is cooling without cracking.

Weekly jobless claims reinforced that narrative. Initial claims fell to 227,000 in the week ended February 7, consistent with stabilization rather than deterioration.⁶ Retail sales, however, hinted at marginal cooling. December sales were unchanged from November, with official characterization describing activity as “virtually unchanged,” though still positive year over year.⁷

Inflation provided the pivot. January CPI rose 0.2% month over month, bringing the year-over-year rate to 2.4%.² Core CPI increased 0.3% on the month and 2.5% year over year.² Energy softness helped the headline, while services categories reflected early-year price resets.⁸ The sequencing is critical. A firm labor print tightened the market’s tolerance for immediate cuts. A softer inflation reading reopened the debate around mid-year easing.

Rate markets translated that balance into a duration bid. The 10-year Treasury yield fell from 4.22% on February 6 to 4.09% on February 12, while the 30-year declined from 4.85% to 4.72%.³ The 10-year minus 2-year spread narrowed modestly, reflecting flattening pressure.³ By Friday, the 10-year traded near 4.067% following the CPI release.⁹

Term premia remain an underappreciated driver. The San Francisco Fed’s yield premium estimates show the 10-year term premium above one percentage point, underscoring that long-end yields reflect compensation for duration risk beyond expected policy rates alone.¹⁰

Operational liquidity also mattered. The New York Fed signaled that elevated reserve-management purchases of Treasury bills and short-dated government bonds would continue into mid-April, framed as technical rather than stimulus-oriented.¹¹ The Treasury General Account remained elevated, keeping near-term liquidity impulses dependent on bill supply and tax flows.¹²

Equities absorbed the macro mix unevenly. A sharp growth-led drawdown tied to AI-related positioning pressure drove major index declines midweek.¹³ Friday’s softer CPI stabilized sentiment, though dispersion remained elevated. Commentary highlighted that internal breadth was healthier than index-level performance suggested, pointing to fragile leadership and rotation beneath the surface.¹⁴

Credit markets did not flash systemic stress. The ICE BofA U.S. High Yield option-adjusted spread widened from 2.87% to 2.92% over the week.⁴ That magnitude aligns with equity volatility and modest risk repricing rather than a funding shock.

In FX, the dollar weakened on the week as rate futures increased the implied probability of a June cut following CPI.¹⁵ U.S. policy commentary also reflected tolerance for a weaker dollar, with the Commerce Secretary describing the currency as closer to a “more natural” level for trade.¹⁶

International Developed Markets: Divergence Re-Emerges

Europe’s story centered less on data and more on narrative. An ECB policymaker argued that Europe should prepare for a larger global safe-haven role, emphasizing stronger liquidity backstops.¹⁷ The euro traded near $1.1863 into Friday, modestly higher on the week.⁵ The implication is structural rather than cyclical. A stronger institutional bid for euro assets alters funding dynamics over time.

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• Central banks are pausing in unison, but policy pivots remain conditional and uneven.

• Labor markets are cooling just enough to sustain rate-cut expectations without confirming recession.

• Equity leadership is rotating toward value, cyclicals, and smaller caps beneath stable index levels.

• A weaker dollar, record gold prices, and emerging-market strength suggest global capital reallocation rather than outright risk-on behavior.

A Pause Before the Pivot

The first week of February delivered a familiar but still consequential outcome: patience. In the United States, the Federal Reserve held interest rates steady, acknowledging gradual softening in labor conditions while emphasizing that progress on inflation remains incomplete. Chair Jerome Powell characterized the economy as “solid,” reinforcing policymakers’ preference to wait for clearer confirmation before shifting course.¹

With the policy decision widely anticipated, attention quickly turned to labor data. A partial government shutdown delayed the official January employment report, leaving markets to rely on alternative indicators. The ADP private payrolls report showed job gains of just 22,000, a sharp undershoot relative to expectations and a sign that hiring momentum is fading more rapidly than forecast.² While unemployment remains historically low and is expected to hold in the mid-4% range, the direction of travel has become increasingly difficult to ignore.³

Bond markets reacted accordingly. Short-dated Treasury yields declined as investors increased bets on eventual rate cuts, while longer-dated yields remained relatively anchored. The result was a persistently inverted yield curve, reflecting confidence that inflation pressures are easing alongside lingering concern about medium-term growth prospects.⁴

Equities extended January’s gains but with noticeably higher volatility. Earnings season exposed investor sensitivity to guidance rather than headline results. Several mega-cap technology companies reported strong quarterly numbers only to see their share prices fall sharply, as markets reassessed valuation and growth durability.⁵ At the same time, select consumer and hardware companies delivered upside surprises that helped stabilize broader indices.

One asset class stood apart. Gold surged to record highs above $5,500 per ounce, supported by a weaker dollar, declining real yields, and elevated geopolitical risk.⁶ The rally signaled not panic, but growing demand for insurance as markets transition away from peak-tightening conditions.

Rotation Beneath the Surface

Beneath relatively calm index levels, leadership continued to rotate. Value stocks extended their outperformance over Growth for a third consecutive month, driven by investor preference for cash-flow durability and valuation discipline.⁷ Cyclical sectors such as Energy, Materials, and Industrials again led the market, supported by higher commodity prices and supply-side uncertainty.⁸

Energy equities benefited from oil’s rebound toward the upper-$60s per barrel, its highest level since late 2025. While global demand growth remains modest, geopolitical risks and tighter inventories have sustained a risk premium in energy markets. Defensive sectors also held firm. Consumer Staples and Utilities attracted steady inflows as investors balanced optimism about easing policy with caution around slowing growth.

Market-capitalization dynamics reinforced the theme of rotation rather than speculation. Small-cap equities, which surged in January, continued to outperform large caps. The Russell 2000’s relative strength reflects easing financial conditions and domestic economic resilience rather than excess risk-taking.⁹ Importantly, leadership within small and mid-cap indices skewed toward profitable firms with improving fundamentals.

Financials lagged, weighed down by compressed yield spreads and uncertainty surrounding loan growth.¹⁰ Within technology, dispersion widened further. Profitable, established companies and AI-linked infrastructure providers continued to attract capital, while higher-valuation speculative growth names struggled to maintain momentum.

Overall, market behavior suggests broadening participation accompanied by selectivity. Investors appear willing to embrace opportunity, but only where quality and downside resilience remain evident.

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Global markets opened the year with a tone of cautious confidence. In the United States, economic momentum remains firm enough to keep the Federal Reserve on hold at its January meeting, with consensus firmly expecting no policy change.¹ Growth has proven resilient, inflation has moderated but remains above target, and policymakers appear comfortable maintaining restrictive settings while they assess how disinflation evolves.¹ Bond markets are already looking ahead. The decline in short-term yields relative to longer maturities reflects expectations that policy easing may arrive later in the year, even as the Fed signals patience.¹

Equity indices, however, tell only part of the story. Major benchmarks have been largely flat, masking a pronounced internal rotation.¹ Volatility remains subdued, suggesting investors are broadly comfortable with the macro backdrop despite political noise and ongoing debates about central bank independence.¹ The message from U.S. markets is not one of exuberance, but of stability paired with a growing willingness to reposition risk.

Rotation Beneath the Surface

That repositioning has been most visible in the shift away from mega-cap dominance. After several years in which a narrow group of large technology companies accounted for an outsized share of returns, leadership has begun to broaden.¹ Small- and mid-capitalization stocks have surged early in the year, recapturing investor attention after prolonged underperformance.¹ Equal-weight equity strategies have also attracted strong inflows, reflecting a desire for diversification away from heavily concentrated benchmarks.¹

This rotation appears tied to both valuation and macro expectations. As interest rate pressures ease and the prospect of future policy accommodation comes into view, investors have shown renewed interest in more cyclical and economically sensitive companies.¹ Energy, industrials, and value-oriented sectors have outpaced growth-heavy areas, while several of last year’s market leaders have stumbled out of the gate.¹ While similar false starts have occurred in the past, the current move has been notable for its breadth and its alignment with a clear policy catalyst: the Federal Reserve’s pause.¹

The durability of this shift remains an open question. If large technology companies simply consolidate rather than resume leadership, conditions remain favorable for smaller firms to continue outperforming.¹ Earnings season will be critical in determining whether this rotation reflects a genuine regime change or merely a temporary adjustment within an ongoing range-bound market.

Diverging Global Paths

Outside the United States, policy inflection points dominate the landscape. In Europe, business activity continues to expand modestly, though momentum is uneven across countries.¹ Inflation has fallen sharply from last year’s highs, allowing the European Central Bank to pause its tightening cycle.¹ At the same time, rising cost pressures in recent survey data have reinforced the ECB’s reluctance to discuss near-term easing.¹ The decision by the U.S. administration to step back from proposed tariffs on European goods has removed a key downside risk, offering relief to exporters and improving sentiment across the region.¹

The United Kingdom faces a more delicate balance. Inflation surprised modestly to the upside late last year, yet policymakers remain confident that price pressures will ease toward target in coming months.¹ With growth showing tentative signs of improvement and the labor market beginning to cool, the Bank of England appears inclined to proceed cautiously, holding rates steady while preparing the ground for gradual easing later in the year.¹

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• U.S. inflation continues to cool without a sharp deterioration in labor markets, reinforcing expectations that the Federal Reserve will remain on hold near term.¹

• Equity leadership is widening meaningfully, with small- and mid-caps outperforming mega-cap technology and signaling healthier market breadth.²

• Globally, disinflation is allowing central banks in Europe, the U.K., and parts of emerging markets to pause or pivot, while Japan begins a historic normalization cycle.³

Resilient Growth and a Shifting U.S. Market Narrative

The U.S. economic backdrop entering early 2026 reflects a rare combination of moderating inflation and continued growth. Consumer prices rose 2.7% year over year in December, with core inflation easing further to 2.6%, underscoring how far price pressures have retreated from their post-pandemic peak.⁴ The labor market has softened only modestly, with unemployment hovering near 4.4%, a level consistent with stability rather than contraction.¹

This balance has allowed Federal Reserve officials to step back from aggressive tightening. After cutting rates late last year, policymakers have signaled patience, emphasizing the need to assess incoming data before making additional moves.⁵ Futures markets still price in rate cuts later in the cycle, but stronger-than-expected retail sales suggest the economy retains momentum.⁶

Equities have responded accordingly. The S&P 500 remains near record highs, supported by earnings resilience and declining volatility.⁷ Temporary pullbacks tied to sector-specific news, including technology export restrictions and uneven bank earnings, have been met with renewed buying interest rather than broad risk aversion.²

Bond markets have reinforced this message. Treasury yields have edged lower as inflation expectations stabilize, easing pressure on valuations without signaling recession fears. The yield curve remains inverted, but the inversion has narrowed, suggesting markets are beginning to look beyond the tightening phase.⁴

Rotation Takes Hold as Market Breadth Improves

One of the most important developments of early 2026 has been the broadening of equity participation. After years of dominance by a narrow group of mega-cap technology stocks, smaller and more cyclical companies are regaining leadership. Both small- and mid-cap indices have reached record highs, while the equal-weighted S&P 500 has meaningfully outperformed its capitalization-weighted counterpart.²

This shift reflects several forces. Valuation dispersion widened significantly in prior years, leaving non-mega-cap segments comparatively attractive. As rate pressures eased, investors began reallocating toward sectors tied more closely to domestic growth, including industrials, materials, and selected financials. The result has been healthier internal market dynamics, with gains distributed across a broader range of companies rather than concentrated in a handful of names.

Sector rotation has followed a similar pattern. Cyclical and value-oriented groups have outperformed, while technology has paused after an extended run. Energy and materials benefited briefly from geopolitical headlines and commodity volatility, while defensive sectors quietly attracted flows during periods of equity consolidation.² Importantly, these rotations appear to reflect repositioning rather than wholesale risk reduction. Capital has remained largely within equities, shifting leadership rather than exiting the market altogether.

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The closing stretch of 2025 has been defined by record equity prices, broadening market participation, and an easing inflation backdrop that few anticipated a year ago. Central banks across developed markets have either paused or begun reversing tightening cycles, while investors have embraced a risk-on posture that has pushed valuations higher and volatility lower. The result has been a year of exceptional asset-price performance, paired with growing debate about how durable these conditions may be as 2026 approaches.

U.S. Macro and Markets

U.S. equities ended the year at fresh highs, with the S&P 500 and Dow Jones Industrial Average both closing at records after gaining solidly in 2025. The Federal Reserve cut rates for a third consecutive meeting in December, lowering the policy range to 3.50–3.75 percent. The decision exposed growing internal divisions, with dissenters split between holding rates steady and pushing for a larger cut. Chair Powell acknowledged the tension between moderating inflation and a labor market that is beginning to soften.¹

Inflation data supported the Fed’s more cautious tone. November consumer prices rose at a slower pace, while unemployment edged higher. Treasury markets responded with a notable decline in short-term yields and a re-steepening of the yield curve as two-year yields fell below long-term rates.² This shift has been interpreted less as a recession signal and more as confirmation that the peak in monetary restriction is likely behind us.

Equities embraced that interpretation. The Nasdaq outperformed on enthusiasm around artificial intelligence and continued earnings resilience among mega-cap firms, while broader benchmarks posted their third consecutive annual gain. Investor confidence has been reinforced by the absence of a clear recession despite aggressive tightening earlier in the cycle. At the same time, the combination of easing policy and still-elevated valuations has narrowed the margin for error going forward.³

Sector and Style Rotation

While mega-cap growth dominated much of the year, the final quarter saw a meaningful broadening of leadership. Small-cap stocks broke out to new highs after years of underperformance, aided by falling borrowing costs and renewed interest in domestically oriented businesses. Cyclical sectors such as industrials and regional banks benefited from this shift, while value-oriented names narrowed the performance gap with growth.⁴

Sector leadership also diversified. Technology and communication services remained strong beneficiaries of the AI cycle, while financials delivered outsized gains as credit conditions improved and the yield curve steepened. Materials stocks advanced sharply on the back of soaring precious-metal prices, while energy lagged as oil prices declined over the year. Defensive sectors such as utilities underperformed amid persistent risk appetite.⁵

This late-year rotation suggests investors are increasingly looking beyond a narrow set of winners. Whether it marks a durable change in leadership or simply a year-end adjustment remains an open question as markets enter 2026.

Developed Markets

Outside the United States, developed markets also posted robust gains. In Europe, the European Central Bank held rates steady in December after earlier cuts, citing improved growth resilience and inflation near its target. Officials emphasized uncertainty around services inflation and geopolitics, signaling a prolonged pause rather than a rapid return to easing. European equity markets responded favorably, with major indices hovering near record levels.⁶

The United Kingdom followed a similar path. The Bank of England cut rates again in December as inflation cooled, though policymakers warned that price pressures are likely to remain above target for some time. Despite these constraints, UK equities rallied strongly, supported by global risk appetite and rebounds in financial and commodity-linked stocks.⁷

Japan marked one of the most significant policy shifts of the year. The Bank of Japan raised rates again in December, continuing its gradual exit from decades of ultra-loose policy. Officials debated the need for further hikes to contain inflation and support the yen, which remained weak despite tighter policy. Japanese equities surged to multi-decade highs, driven by earnings growth, shareholder reforms, and renewed global interest in the market.⁸

Emerging Markets

Emerging markets presented a more mixed picture. China’s economy slowed into year-end as industrial output and retail sales weakened, reflecting persistent property-sector stress and soft domestic demand. Policymakers signaled a preference for targeted fiscal measures and structural reform rather than large-scale stimulus, even as trade surpluses hit record levels. Chinese equities rallied in the second half on policy optimism, but investor confidence remains fragile.⁹

India stood out as a relative bright spot. Inflation fell sharply, giving the Reserve Bank of India room to cut rates multiple times during the year. Domestic demand remained resilient, and growth expectations were revised higher. Equity markets reached record levels, though gains moderated toward year-end amid global capital flows.¹⁰

Latin America reflected divergent paths. Brazil’s central bank held rates at elevated levels to anchor inflation expectations despite slowing growth, while Mexico and Chile continued easing cycles as inflation cooled. Across emerging markets, a weaker U.S. dollar and global disinflation provided support, even as commodity price volatility created uneven outcomes.¹¹

Currencies and Cross-Market Signals

Currency markets reinforced the year’s broader themes. The U.S. dollar suffered its worst annual decline in years as interest-rate differentials narrowed and investors rotated away from dollar-centric trades. Most major currencies appreciated, led by the euro and Swiss franc, while the yen lagged amid cautious Bank of Japan tightening.¹²

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• Markets are embracing a soft-landing narrative as central banks pivot toward easing, even as labor markets loosen and growth signals become more uneven beneath the surface.

• The Federal Reserve’s rate cuts have supported risk assets, with cooling inflation and rising unemployment giving policymakers room to ease without immediately signaling recession.

• U.S. equity leadership remains narrow, as mega-cap stocks continue to dominate while small caps and cyclicals lag, reflecting late-cycle investor preferences.

• Global conditions are diverging, with Europe stabilizing faster than expected, Japan navigating a historic policy shift, and emerging markets following increasingly distinct paths.

• Cross-market signals point to caution, as record gold prices, a weaker dollar, and improving defensive performance contrast with equity-market optimism.

Central Banks Pivot as Markets Celebrate

As 2025 moves through its final stretch, markets are grappling with a familiar paradox. Asset prices continue to climb, buoyed by easing monetary policy and cooling inflation, even as underlying economic signals grow more uneven. Central banks have begun to pivot, investors are leaning into the soft-landing narrative, and risk assets are behaving as though the cycle’s most difficult phase is already behind us. Beneath the surface, however, labor markets are loosening, growth is diverging across regions, and risk appetite is becoming more selective.

In the United States, the Federal Reserve has now delivered three consecutive 25-basis-point rate cuts, bringing the federal funds target range to 3.50%–3.75%.¹ Recent inflation data has given policymakers room to maneuver. Core consumer prices have slowed to roughly 2.6% year over year, the lowest pace in four years, while the unemployment rate has risen to 4.6%, its highest level since early 2021.² Together, these trends suggest that restrictive policy is finally gaining traction.

Markets have responded enthusiastically. The S&P 500 has pushed to fresh record highs, extending a powerful rally fueled by falling yields and resilient growth data. Third-quarter GDP surprised to the upside, expanding at a 4.3% annualized pace and reinforcing the view that policy easing does not necessarily imply an imminent recession.³ Volatility has eased, financial conditions have loosened, and risk assets have broadly benefited.

A Narrow U.S. Rally

Equity leadership, however, remains concentrated. Large-cap stocks continue to dominate performance, while smaller companies lag meaningfully behind. The Russell 2000 has posted only modest gains, underscoring investors’ ongoing preference for scale, balance-sheet strength, and earnings visibility.⁴ Periodic bursts of small-cap outperformance have appeared when expectations for rate cuts intensified, but those rotations have faded quickly.

Sector performance reflects a late-cycle tension. Growth stocks have reasserted leadership in recent weeks, but defensive areas have quietly gained traction. Healthcare, utilities, and consumer staples have outperformed during bouts of market uncertainty, suggesting that investors are hedging even as indexes grind higher. Credit spreads have tightened modestly, though enthusiasm for lower-quality risk remains measured rather than exuberant.

For now, U.S. markets appear to be pricing a near-ideal scenario: inflation continues to cool, growth remains intact, and the Fed eases policy without sacrificing credibility. History suggests that such equilibrium tends to be temporary.

Europe Finds Its Footing

Europe enters the final stretch of the year in better shape than many anticipated. After flirting with stagnation earlier in 2025, economic activity has stabilized. Purchasing-manager surveys have moved back into expansion territory, inflation is hovering near the European Central Bank’s 2% target, and policymakers have signaled that the tightening phase is firmly in the rearview mirror.⁵

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• Central bank divergence intensified into year-end. The Federal Reserve signaled a pause after its latest cut, while the Bank of Japan tightened further and European policymakers leaned toward stability rather than additional easing.

• Market leadership broadened meaningfully. Small-cap and cyclical stocks outperformed as investors rotated away from stretched mega-cap technology, improving overall market breadth.

• The U.S. economy cooled without cracking. Inflation continued to ease while labor market data softened, reinforcing expectations of a late-cycle slowdown rather than a sharp recession.

• Europe surprised to the upside. Improving business activity and inflation near target allowed the ECB to hold rates steady, supporting the euro and stabilizing regional markets.

• Emerging markets diverged sharply. India sustained strong growth momentum, Brazil benefited from earlier policy discipline, and China remained constrained by weak confidence and property stress.

• Cross-asset signals pointed to normalization, not stress. Yield curves re-steepened, volatility stayed contained, and risk appetite improved, even as elevated cash balances reflected caution.

The final weeks of 2025 underscored how fragmented the global macro environment has become. While the Federal Reserve moved toward the sidelines after its latest rate cut, other major central banks pushed policy in different directions. Investors responded not by abandoning risk, but by shifting leadership within markets. As 2026 approaches, divergence—across monetary policy, regions, and asset classes—has replaced synchronization as the defining theme.

The Fed Pauses as Markets Reprice the Cycle

The Federal Reserve closed the year with a third consecutive rate cut, lowering the federal funds target range to 3.50%–3.75%. Chair Jerome Powell emphasized uncertainty and described policymaking as “driving through fog,” signaling that further easing is no longer automatic. Recent data support that caution. The U.S. unemployment rate climbed to 4.6% in November, its highest level in more than four years, even as payroll growth recovered modestly following an October slowdown.¹

Inflation trends have given the Fed room to pause. Headline consumer prices rose 2.7% year over year in November, the slowest pace since early 2021, while core inflation eased to 2.6%.² Together, softer inflation and cooling labor conditions suggest an economy decelerating toward trend rather than slipping abruptly into recession.

Bond markets reacted decisively. Treasury yields fell across the curve, and the long-running inversion finally reversed. The spread between 10-year and 2-year yields turned positive for the first time in over two years, reflecting expectations that policy is no longer restrictive enough to choke off growth.³ Equity markets absorbed the shift with relative calm. December trading proved choppy, but the S&P 500 still finished the year firmly higher, extending a multi-year run of strong performance.⁴

A Rotation Beneath the Surface

Beneath the surface of headline indexes, leadership shifted meaningfully. After years of dominance by mega-cap technology stocks, the fourth quarter saw investors rotate toward smaller companies and more cyclical sectors. Falling interest rates improved financing conditions for smaller firms, while stretched valuations in large-cap growth encouraged profit-taking.⁵

At the same time, enthusiasm around artificial intelligence began to cool. Investors grew more selective as questions emerged about the timing and scale of returns on massive AI infrastructure spending.⁶ The result was not a collapse in technology stocks, but a pause that allowed other segments of the market to participate more fully.

This broadening of participation matters. Rallies driven by a narrow group of stocks are inherently fragile, while advances supported by multiple sectors and styles tend to be more resilient. Increased contributions from small caps, industrials, and value-oriented areas suggest a healthier market foundation, even if the transition introduces short-term volatility.

Europe Finds Its Footing

Europe ended the year in better shape than many anticipated. Business activity surveys showed expansion at the fastest pace in more than two years, driven largely by a resilient services sector that offset ongoing manufacturing weakness.⁷ Inflation across the eurozone has largely converged with the European Central Bank’s target, giving policymakers confidence to hold rates steady after a year of easing.⁸

At its December meeting, the ECB left policy unchanged and upgraded its growth outlook, signaling that the disinflation phase is largely complete.⁹ This steady stance helped support the euro, which strengthened meaningfully against the dollar into year-end.¹⁰ Europe enters 2026 with improving momentum, inflation under control, and a central bank focused on maintaining stability rather than reigniting stimulus.

The United Kingdom and Japan Take Different Paths

In the United Kingdom, the Bank of England cut rates by 25 basis points after inflation fell faster than expected. The decision, however, revealed sharp divisions within the Monetary Policy Committee. Several members favored easing to support a stagnant economy, while others warned that inflation risks remain elevated relative to peers.¹¹ Markets now expect any additional cuts to be gradual and closely tied to incoming data.

Japan moved in the opposite direction. The Bank of Japan raised its policy rate to 0.75%, the highest level in three decades, marking another step away from ultra-accommodative policy. Policymakers expressed growing confidence that wage growth and inflation expectations are becoming self-sustaining.¹² Yet the yen weakened after the decision as investors concluded that further tightening would proceed slowly. Japan’s policy shift remains cautious, but its global implications are increasingly significant.

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Source: YCharts

Europe offered a more straightforward storyline. The eurozone composite PMI reached a 30-month high.² Inflation eased to 2.2%, essentially matching the ECB’s target.³ The UK remained the inflation outlier with CPI stuck at 3.8%, the highest in the G7, raising expectations for another BoE cut.⁴ Japan moved in the opposite direction: new fiscal spending and firmer exports strengthened the case for the Bank of Japan to consider its first meaningful rate hike in years.⁵

Cross-asset flows reflected similar tension. Money-market assets climbed to a ten-month high as investors sought safety.⁶ Yet global equities still attracted inflows. The U.S. yield curve remained roughly 50 bps inverted.⁶ Currency markets added drama: the dollar softened on expectations of Fed easing, while the yen briefly spiked as traders priced in BoJ tightening before retreating.⁷ ⁸

U.S. Macro & Market Backdrop

With official data delayed, investors were left to decipher contradictory labor signals. Revelio Labs estimated job losses in November even as jobless claims hit their lowest reading since 2022.¹ Layoff announcements, which had surged in October, fell sharply.¹ The overall impression: an economy cooling unevenly, not collapsing.

Expectations for rate cuts hardened quickly. Fed funds futures now imply an 85% chance of easing at the December meeting.⁷ Reports that the White House is considering a more dovish successor to Chair Jerome Powell strengthened that view.⁷ Treasury yields drifted lower, with the 10-year near 4% and the 2-year around 3.5%, maintaining a modest inversion.⁶

Source: YCharts

Equities reflected that uncertainty. After a strong autumn, the S&P 500 stalled on low volume. Defensive sectors such as utilities and healthcare outperformed, while high-beta names softened. With earnings decelerating and the Fed’s path shifting, markets appear to be waiting for clearer direction from both incoming data and policymakers.

Developed Markets

Europe

The eurozone continued to outperform expectations. The composite PMI climbed to 52.8.² Inflation hovered near target.³ ECB officials expressed confidence that inflation is “largely defeated”.³ Markets do not expect rate cuts until late 2026.³ Unemployment remains low, and surveys point to an economy holding up better than feared.³

United Kingdom

Britain’s inflation challenge persists. CPI held at 3.8%.⁴ Services inflation remains elevated.⁴ The Bank of England, having already cut rates five times since August 2024, now sits at 4.0%.⁷ Markets expect another cut soon. Fiscal tightening introduced in November may ease inflation next year, though household inflation expectations remain high.⁴

Japan

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Beneath the optimism, the macro picture looks less convincing. Unemployment has drifted higher, layoffs have accelerated, and retail indicators point to consumer fatigue.⁵ Recent Fed minutes reflected a divide: some officials questioned moving too quickly, while others argued that a weakening labor market justified further easing.¹ Futures markets now largely expect a December cut as disinflation continues and growth slows.

This tension—rising asset prices amid deteriorating fundamentals—has produced a striking split: heavy inflows into equities alongside record cash balances. Money market funds now hold more than $7.5 trillion,⁴ suggesting many investors are participating in the rally while still hedging against downside risks. Volatility remains subdued, but the fragility beneath the surface keeps an undercurrent of caution alive.

Rotation Signals a Preference for Stability

Equity leadership remains concentrated in mega-cap technology and communication services, while smaller companies have narrowed the gap only modestly. Growth stocks continue to outperform as falling yields boost longer-duration assets. Defensive sectors have also shown signs of life. Utilities and consumer staples—two groups that lagged for much of the year—have attracted renewed interest as investors quietly probe for safety.⁵

Factor behavior suggests a similar tone. Low-volatility and high-dividend stocks have outperformed high-beta names in recent weeks,⁵ even as headline indices press higher. The pattern is consistent with late-cycle positioning: stay invested, but maintain ballast.

Europe Sees Stability, but Only in Moderation

Across the eurozone, the macro environment is slowly improving. Recent PMI data shows modest expansion, led by the services sector, while inflation has cooled back toward the ECB’s 2% target.⁷ With this progress, the central bank has held policy steady and signaled that the tightening cycle is likely finished.⁸

A stronger euro has reinforced the sense of stability. EUR/USD recently touched multi-month highs,¹⁶ supported by fading recession fears and a weaker U.S. dollar. Equity markets have responded positively, helped by lower energy prices and reduced concerns about a deep downturn. Still, expectations for 2026 growth remain modest.

The UK Leans on Fiscal Tightening for Credibility

Britain’s latest budget took center stage as officials attempted to restore fiscal credibility after a turbulent period in U.K. markets. The plan emphasized tax increases and deficit reduction, helping to steady gilt yields and lifting sterling above $1.32.² Investors had braced for a more disruptive outcome, so the relief was immediate.

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Key Takeaways

• A 43-day U.S. government shutdown erased major economic releases, forcing markets to trade without CPI or jobs data.¹

• Fed officials are split on a possible December rate cut, keeping volatility elevated and narrowing market leadership.²

• Europe shows rare stability: PMIs remain above 50 and inflation sits near the ECB’s 2% target, while the UK continues to stagnate.³⁹

• Japan inches closer to a historic policy shift as inflation stays above target and exports surprise higher.⁴¹¹

• China’s slowdown contrasts with India’s strong, disinflationary growth trajectory, while Latin America prepares its easing cycle.

Markets spent the past week sorting through a macro environment that suddenly lost its most important signals. A 43-day federal shutdown wiped out key U.S. data releases, including October’s CPI, and pushed the jobs report into next month.¹ The vacuum created fertile ground for speculation over whether the Federal Reserve might move toward a December cut.² Stocks slid early, with the S&P 500 down roughly 2% before a late-week rebound softened the losses.²

The missing U.S. data overshadowed a steadier global backdrop. Europe’s expansion continued, with the eurozone flash PMI marking its eleventh straight month above 50.³ Inflation hovered close to the ECB’s 2% target.³ Japan, meanwhile, showed renewed price pressures as core CPI accelerated to 3.0%—its highest in more than three years.⁴ Risk appetite cooled accordingly: global equity inflows fell to their lowest level in over a year, while bond funds attracted nearly $9 billion as investors leaned defensive.⁵ Treasury yields eased, steepening the curve slightly but leaving it firmly inverted, a reminder that markets still harbor doubts about the growth outlook.⁶

United States: Flying Blind Into Year-End

The shutdown left markets without a crucial read on price levels or employment conditions. The October CPI never arrived.¹ Employment data were delayed. That absence forces investors to trade around narratives instead of numbers. What we do know: unemployment rose to 4.4% in September, a four-year high.⁷ Inflation at last check was hovering near 3%, still above target.

This uncertainty spilled directly into monetary policy expectations. Some Fed officials argue that rising unemployment supports a December cut. Others insist inflation remains too sticky.² Futures pricing has swung between optimism and skepticism and now sits near coin-flip odds. Volatility has crept higher as traders attempt to reconcile conflicting storylines, and the VIX recently touched its highest level since April.²

Fund flows reflected the same indecision. Equity inflows collapsed after strong early-November enthusiasm.⁵ Bond funds continued to attract fresh capital as investors looked for stability.⁵ Treasury yields drifted lower, with the 10-year settling near 4.0%, but the curve remains deeply inverted—around –45 basis points—suggesting markets still see growth risks ahead.⁶

Market leadership remains narrow. Mega-cap tech stabilized after strong earnings from Nvidia, yet the recovery lacked breadth.² Defensive pockets—utilities, healthcare, and energy—drew measured buying, and healthcare funds logged their first inflow in a month.⁵ Growth remains dominant year-to-date, but the quiet rotation toward quality indicates investors are hedging their optimism.

Europe: A Rare Period of Predictability

Europe, unusually, has become the calmest part of the global macro picture. Business activity expanded again in November, with the composite PMI unchanged near 52.³ Inflation has largely converged to the ECB’s target range.³ With price stability restored and growth holding, the ECB has paused for three consecutive meetings and signaled that its tightening cycle is effectively finished.⁸

The euro has traded near its strongest levels in almost two years.⁶ Fiscal policy across the region is set to turn slightly restrictive in 2026, but not enough to derail the recovery. Barring an energy-related setback, Europe seems positioned to enter next year with moderate growth, stable inflation, and much-improved visibility.

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This Week at a Glance

Markets cooled after an exuberant October. In the U.S., private data hinted at a softer labor market, with unemployment near 4.4% and planned layoffs at a 22-year high¹². The S&P 500 fell roughly 2.4% from recent highs but remains up double digits year-to-date³.

Abroad, the eurozone showed renewed momentum: the composite PMI reached 52.5, its best level in nearly 30 months⁴, while inflation stabilized around 2%⁵. Japan’s new government turned expansionary, pledging stimulus even as exports rose 4.2% in September⁶.

Flows revealed tension between optimism and caution. Global equity funds drew $22 billion⁷, yet money-market holdings surged to a 10-month high⁸. The dollar weakened on rate-cut bets, while the euro and yen advanced modestly.

U.S. Macro & Markets

The post-AI rally hit pause. The S&P 500 slipped 2.4% over eight sessions⁹; semiconductors fell 2.4%¹⁰. Absent official data during the government shutdown, investors relied on private indicators: the Chicago Fed’s estimate of 4.4% unemployment¹ and Challenger’s report of 153,000 planned layoffs—an 183% jump from last year².

Despite warning signs, inflows remained robust. Large-cap funds added $12.6 billion¹¹ ⁷, the largest since early October, while small- and mid-caps lagged¹². Treasury yields held firm, with the 10-year near 4.1% and the 2-year 3.6%, leaving the curve ~0.55% inverted¹³ ¹⁴.

For now, equities balance easing expectations with weakening fundamentals—a recipe for volatility if inflation or growth data surprise.

Sector & Style Rotation

Large-cap strength persisted. Investors funneled $11.9 billion into those funds¹² and $2.4 billion into tech¹⁵, while mid-caps lost $1.2 billion. Growth and AI themes remain dominant, though valuations are drawing scrutiny¹⁰.

Defensive sectors outperformed: consumer discretionary dropped 2.5% (week’s worst), while energy gained as oil prices steadied¹⁶. The rotation suggests investors prefer blue-chip quality and cash-flow resilience over high-beta exposure.

Developed Markets

Europe. The eurozone’s PMI hit 52.5⁴, signaling expansion led by services; manufacturing hovered near 50¹⁷. Inflation eased to ~2.1%⁵ (core 2.4%), aligning with the ECB target. Rates have held at 2% for three meetings¹⁸, and a Reuters poll showed consensus that tightening is over¹⁹. Policymakers expect inflation to settle at 2% next year²⁰. The euro strengthened to about $1.155 on confidence in ECB stability²¹.

United Kingdom. Inflation remains elevated at 3.8% —the highest among the G7²² but below forecasts. With Bank Rate at 4%, traders see a 75% chance of a December cut²³. The November 26 budget will weigh fiscal tightening against persistent services inflation (~4.7%).

Japan. Prime Minister Takaichi signaled fiscal expansion and potential tax cuts²⁴, complicating the BoJ’s plans. While October minutes show many members favor rate hikes, the yen’s weakness (+4.2% export boost in September) provides short-term relief⁶. U.S.-bound shipments fell 13%, keeping Japan in deficit. The new fiscal-monetary dynamic could reshape Asia’s policy balance.

Emerging Markets

China. Growth continues to slow, with Q3 GDP expected around 4.5–4.8% year-over-year²⁵. Property weakness deepened—home prices fell 0.4% in September across 63 cities²⁶. Low inflation and soft confidence have spurred expectations for further stimulus: a 10-bp rate cut in Q4²⁸ and 500 billion yuan in policy funds for infrastructure and high-tech projects²⁹. Trade relations with Washington remain fragile, though a truce to reduce tariffs could take effect by 2026²⁷.

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• U.S.: The Federal Reserve delivered a second straight rate cut, trimming the policy rate to 3.75–4.00%, while hinting at a pause amid a federal data blackout.
• International: A one-year U.S.-China trade truce was announced, easing tariff tensions even as Europe’s central bank held rates steady and Japan’s new leadership signaled continuity in ultra-easy policy.
• Markets: The S&P 500 pulled back slightly from record highs after Fed Chair Powell’s cautious tone, but is still poised for its longest streak of monthly gains in four years. Bond yields climbed alongside a surging U.S. dollar, and oil prices steadied, keeping cross-asset signals in focus.

The Federal Reserve delivered a second consecutive rate cut, trimming its policy rate to 3.75–4.00% while hinting at a pause amid limited economic data access due to the federal shutdown¹. Chair Jerome Powell’s cautious tone suggested that “driving in the fog” means the central bank will slow further easing until clarity returns². The split 10–2 decision reflected internal debate—one official favored a deeper cut, another no cut at all³.

Markets initially rallied but reversed as Powell downplayed the odds of another cut this year. The S&P 500 ended flat near record highs, Treasury yields rose, and volatility edged higher. The 2-year yield climbed above 4.3%, while the 10-year hovered near 4.7%, modestly re-steepening the yield curve⁴. With unemployment at 4.3% and core inflation at 2.7%⁵, the Fed appears to be balancing between easing too little and too much. The result: a “hawkish cut” that keeps markets guessing.

Developed Markets: Diverging Paths

Europe. The European Central Bank (ECB) held rates at 2.0%, enjoying a “Goldilocks” moment as inflation nears 2% and growth stabilizes⁹. President Christine Lagarde described policy as “in a good place,” though global trade frictions and soft manufacturing data linger¹⁰. With Germany flirting with recession, the ECB is expected to remain on hold through 2026, and the euro languishes near $1.05.

United Kingdom. The Bank of England kept its base rate at 4.0% as inflation remains stubborn at 3.8%, with core services running at 4.7%¹¹. While some policymakers argue the fight against inflation isn’t over¹², slowing growth suggests rate cuts may begin in early 2026¹³. For now, the pound holds steady near $1.22 amid policy stalemate.

Japan. Under new Prime Minister Sanae Takaichi, the Bank of Japan kept its benchmark rate at 0.50%¹⁴. Inflation has topped the 2% target for 41 straight months, yet the BoJ remains committed to ultra-easy policy, projecting moderation to 1.8% in 2026¹⁵. The yen slid to ¥153 per dollar—a multi-year low—while the Nikkei edged up, signaling confidence in policy continuity. Still, the Ministry of Finance may intervene if yen weakness deepens¹⁶.

Emerging Markets: China Slows, India Accelerates

China. Growth continues to falter. Q3 GDP rose 4.8% year-on-year, down from 5.2% in Q2¹⁷. Retail sales and property investment remain weak, though exports have held up thanks to aggressive discounting abroad¹⁸. Beijing responded with stimulus: mortgage-rate cuts, relaxed home-purchase rules, and liquidity injections. A temporary U.S.-China trade truce has eased tensions, helping stabilize the yuan near ¥7.10 per dollar¹⁹. Still, China’s rebound depends on sustained policy support.

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