Macro
Recent U.S. data continue to suggest a gradually cooling but still resilient economy, though divergence across sectors and income groups is becoming more visible. ADP private payrolls increased by 63,000 in February, signalling continued, though moderate, labour market resilience. The Federal Reserve’s Beige Book highlights this uneven backdrop, with seven districts reporting slight to moderate growth while five reporting flat or declining activity, suggesting an economy increasingly operating at two speeds. Consumer spending remains a key watch point as firms report greater price sensitivity and weaker discretionary demand, particularly among lower-income households.
Attention now turns to next week’s PMI releases, which will provide an updated view of economic momentum across both manufacturing and services. The latest official data showed ISM services at 53.8 in January, indicating continued expansion in the sector that drives the majority of U.S. economic activity, while ISM manufacturing rose to 52.6, marking the first expansion in roughly a year and the strongest reading since 2022. Taken together, the recent data suggest the economy remains resilient despite tighter financial conditions, reinforcing the view that the Federal Reserve can remain patient before beginning its easing cycle.
This uneven price dynamic increasingly reflects a K-shaped consumption environment. Government forecasts suggest grocery prices will rise around 2.5% in 2026, below the long-term average but still increasing for several staples, including beef, sugar, and non-alcoholic beverages, while some categories, such as eggs, may decline. Because food-at-home accounts for a larger share of spending among lower-income households, grocery inflation continues to weigh more heavily on the bottom half of consumers. In contrast, food-away-from-home prices are expected to rise by about 3.7%, primarily affecting higher-income households that spend more on restaurants and discretionary services. The result is a widening divergence in spending patterns, with inflation in essential goods pressuring lower-income consumers while service inflation is more concentrated among higher earners.
For policymakers, the macro picture still supports a patient and data-dependent Federal Reserve stance, with markets broadly expecting the first rate cuts around mid-year unless growth weakens materially. Fiscal dynamics are also returning to focus as Congressional Budget Office projections point to wider deficits in the coming years, partly reflecting lower-than-expected tariff revenues. Markets are also debating the labour implications of AI. While macro data do not yet show broad job displacement, early adoption appears to be compressing white-collar roles and reducing hiring intensity as firms experiment with smaller teams supported by AI tools. Early effects would likely first appear in hiring patterns rather than in unemployment, reinforcing the possibility that productivity gains emerge gradually through organisational restructuring rather than through immediate labour market disruption.
Geopolitical risks intensified sharply as tensions around Iran escalated into active military confrontation involving the United States and Israel. Washington has assembled one of the largest military deployments in the region in decades, including multiple carrier groups and expanded air defence systems. Initial strikes targeted Iranian leadership and strategic infrastructure, while Iran has begun retaliatory attacks across regional targets. Although diplomatic talks continue, the situation remains fluid, and the risk of broader regional escalation persists.
For markets, the key transmission channel is energy supply risk through the Strait of Hormuz, one of the most critical oil shipping routes globally. Early disruptions to shipping have already emerged, and analysts warn that attacks on tankers, pipelines, or regional energy infrastructure could remove several million barrels per day from global supply if the conflict intensifies. As a result, investors are closely watching oil markets, safe-haven flows into U.S. Treasuries, and the broader implications for global growth should a sustained energy shock materialise.
Rates
Treasuries rallied into the end of February before volatility returned as investors reassessed geopolitical risks, energy prices, and the Fed policy outlook. The Federal Reserve policy rate remains at 3.75% (unchanged at the January 27–28 FOMC meeting), with the effective federal funds rate near 3.64%. Market expectations for easing have shifted materially. SOFR futures now imply roughly 35 to 40 basis points of total rate cuts by the end of 2026, while the probability of a near-term move remains extremely low. Markets assign virtually no chance of a rate cut at the March 17–18 FOMC meeting, and the probability of three cuts this year has fallen to around 20%, down sharply from almost 50% a week earlier. Options positioning has also become more defensive (as discussed last week), with traders increasingly hedging against scenarios in which only one rate cut occurs in 2026.
Treasury yields initially declined across the curve during the final week of February. By the end of the week, the 2-year yield closed at 3.381%, the 10-year at 3.945%, and the 30-year at 4.615%. Over the week, yields declined broadly, with the 2Y falling 8.4 bps, the 10Y declining 8.8 bps, and the 30-year dropping 7 basis points. Over the month of February, the long bond yield declined roughly 24 basis points, marking the largest monthly drop since February 2025. Curve dynamics were mixed. The 5s30s spread widened slightly to about 111 bps, indicating modest steepening during the week as front-end yields declined faster. However, the broader monthly trend remained flattening, with the 2s10s spread narrowing from roughly 74 bps at the start of February to around 56 bps.
The primary catalyst for the shift in sentiment has been geopolitical risk and its implications for inflation. Oil prices surged following U.S. and Israeli strikes on Iran, raising concerns about disruptions to global energy supply. WTI crude rose from about $65.6 to $67.0 per barrel during the week, while Brent increased from roughly $70.8 to $72.5 before accelerating sharply after the escalation. Since the strikes, crude prices have risen more than 15%, with Brent crude recently trading near $84 per barrel and WTI approaching $78 per barrel. Tensions around the Strait of Hormuz, which carries roughly 20% of global oil flows, have intensified supply concerns.
Inflation expectations have responded quickly. 2Y breakeven inflation rates rose from about 2.80% to above 2.90%, reaching their highest level since April 2025. 5Y breakevens increased to roughly 2.51%, while 10Y breakevens moved to around 2.30%. Strategists estimate that a 25% increase in crude oil prices could add approximately 0.5 percentage points to headline CPI, complicating the Fed’s ability to ease policy in the near term and pushing investors to demand greater inflation protection.
Federal Reserve officials have adopted a cautious stance as they evaluate the inflation implications of the energy shock. Minneapolis Fed President Neel Kashkari said it is too early to determine the magnitude or persistence of the inflation impact, emphasising the need to assess how large and how long the energy shock lasts. New York Fed President John Williams noted that the transmission would likely occur through oil prices, financial conditions, and asset markets, while reiterating that the current policy range remains appropriate for now. He continues to expect inflation to decline toward 2.5% this year and 2% by 2027, though tariffs and energy costs remain upside risks.
Resilient economic data continue to support the view that the FED can remain patient before beginning its easing cycle. Together with higher energy prices, this backdrop suggests inflation risks remain present. In the $30 trillion Treasury market, inflation concerns have once again become the dominant driver of expectations, pushing investors to reassess both the timing and scale of the next easing cycle.
Credit
Credit spreads widened modestly into the month-end, but the more important shift is internal dispersion, not broad-market stress. Index levels remain contained due to strong technical demand, while pressure is building in software-linked credit, leveraged loans, and parts of private credit exposed to the AI capex cycle.
Global investment-grade spreads moved wider during the week, marking the largest deterioration since November. Asian IG dollar spreads widened roughly 2bp on Friday, while global IG premiums widened nearly 4bp for the week. In the U.S., high-yield spreads widened by 21 bp this week, with the index returning –0.22%. U.S. IG spreads reached ~82bp, up from ~73bp earlier in the month, while February spreads widened to roughly 110bp, the largest monthly move since last April’s tariff volatility. In Europe, iTraxx Crossover rose to ~261bp, and iTraxx Main widened to ~55bp, both the highest since November.
The most visible deterioration remains in leveraged loans. The Bloomberg U.S. Leveraged Loan Index fell 1.34% in February, the steepest monthly decline in more than three years. Weakness is concentrated in software and services. More than 15% of U.S. technology loans now trade at distressed levels, with the distress ratio rising to ~15.4% from ~9.6% at the start of the year. Technology has overtaken basic industry as the most distressed segment in the loan universe.
AI infrastructure financing continues to reshape credit markets. CoreWeave highlighted the scale of the funding cycle, with financing supported by two Meta contracts totalling roughly $14.2bn and $5bn, for a combined total of about $19bn. These contracts are being used to support a loan structure expected to close next month and potentially achieve investment-grade funding economics. The company is expected to burn cash for roughly 18 months, while projected capex increased to $35bn versus $30bn previously. Structures linked to hyperscaler contracts, special-purpose vehicles, and structured credit vehicles are increasingly used to finance the data centre buildout.
Credit fundamentals beneath the surface remain fragile. High-yield default rates are roughly 6%, elevated relative to historical averages. Strategists increasingly describe the environment as one with fat tail credit risk, where sector-specific shocks, particularly in software, could trigger outsized spread repricing as refinancing cycles approach.
Despite this, investment-grade technicals remain strong. Coupon reinvestment flows and redemption proceeds continue to anchor demand, while new-money inflows into IG funds are up roughly 46% year to date. IG spreads remain only about 12 bp off multi-decade tights, illustrating how strong technical demand is offsetting sectoral pressure.
Primary markets remain very active. U.S. IG issuance exceeded $120bn in February, just shy of a monthly record. Abbott Labs priced a $20bn deal, while additional supply pushed weekly issuance near $60bn. Bank of America forecasts around $240bn of U.S. IG issuance in March as borrowers continue to front-load funding. High-yield issuance remained steady, with about $30bn printed in February, marking the second consecutive month at that level and the busiest February since 2021.
Software exposure remains the key fault line between public and private credit. Software represents roughly 6% to 7% of benchmark credit indices but closer to 23% to 24% of BDC portfolios, reflecting direct lending exposure to middle-market software companies without IG market access. This concentration explains why private credit vehicles and BDCs are experiencing materially greater stress than public IG markets.
The AI infrastructure cycle is forcing convergence across capital markets. Hyperscalers have already issued roughly $55bn in public debt across currencies this year, while total industry capex budgets exceed $600bn. Public debt linked specifically to hyperscalers is expected to reach roughly $145bn, with financing spread across public bonds, private credit, asset-backed structures, and private placements.
Overall, credit markets remain liquid and well bid at the index level, but internal leadership has shifted. Defensive sectors such as utilities, pharmaceuticals, energy, and non-cyclical consumer names are outperforming, while software, leveraged loans, and AI-exposed issuers are under pressure. The result is a market where headline spreads remain stable, but sector dispersion is widening, making credit selection increasingly important as the AI investment cycle progresses.
Equities
U.S. equities finished the week lower across the major benchmarks, extending the recent consolidation in risk assets. The Dow declined 1.31%, the S&P 500 slipped 0.43%, the Nasdaq fell 0.95%, and the Russell 2000 dropped 1.18%. Beneath the index-level weakness, however, internal dynamics were more constructive. The equal-weight S&P 500 ended the week in positive territory and outperformed the cap-weighted index by roughly 85 basis points, highlighting improving market breadth and a continued shift away from the narrow mega-cap leadership that has dominated much of the past year.
Sector performance underscored a clear defensive tilt. Utilities led with a gain of 2.9%, followed by consumer staples (+2.7%), health care (+2.1%), and energy (+2.0%), while materials (+1.3%) and real estate (+0.7%) also advanced. Communication services finished modestly higher (+0.5%), and industrials were broadly unchanged. In contrast, cyclical growth areas lagged, with information technology down 2.2%, financials declining 1.9%, and consumer discretionary slipping 0.5%. Weakness was concentrated in large technology names and semiconductors, with Nvidia falling 6.7% for the week despite reporting strong earnings, while broader pressure was also visible across memory, technology components, apparel, hotels, airlines, banks, and credit cards. Strength instead emerged in defensive and commodity-linked segments, including managed care, pharmaceuticals, precious-metals miners, energy producers, defence contractors, property-and-casualty insurers, and beverage companies.
Cross-asset markets reflected a similar shift toward caution. U.S. Treasuries moved modestly higher with some curve steepening during the week, while the U.S. dollar strengthened, with the DXY index rising 0.6%. Precious metals rallied strongly, with gold advancing 3.3% and silver surging 13.3%. Energy markets were stable to firmer, with WTI crude gaining 0.8%, while risk-sensitive assets lagged, including Bitcoin futures, which declined 3.1%. The divergence between defensive assets and equities reinforced the broader theme of rising uncertainty around growth, technology positioning, and geopolitical risks.
One of the key overhangs for markets was renewed debate around the economic implications of artificial intelligence. A research note outlining potential large-scale displacement of white-collar employment, weaker consumption dynamics, and possible stress in private credit markets triggered a sharp early-week sell-off in software stocks estimated at roughly $220 billion in market value. AI-linked companies came under pressure, including IBM, while semiconductor sentiment weakened further, with Nvidia declining despite strong earnings, reflecting positioning and growing concerns that expectations for AI demand may already be stretched. These fears intensified after a technology company surged nearly 20% following the announcement of a roughly 40% workforce reduction tied to AI-driven restructuring, reinforcing market concerns about potential labour-market disruption.
At the same time, the more pessimistic interpretation of AI’s economic impact faced pushback from parts of the investment community. Critics argued that technological transitions have historically expanded productivity and economic activity rather than destroyed them, while evidence of large-scale AI-driven labour displacement remains limited. Structural factors such as platform scale, supply constraints in advanced computing infrastructure, and policy responses were cited as potential stabilizers. Sentiment improved modestly later in the week after an enterprise-focused AI event that highlighted collaboration between human workers and AI systems rather than outright substitution. Combined with already heavy bearish positioning in software and several constructive earnings takeaways, these factors helped prevent a deeper drawdown in the sector.
Geopolitics also remained in focus. Tensions surrounding negotiations between the United States and Iran continued to generate mixed headlines, with diplomatic talks expected to resume after indications of some progress in earlier discussions mediated by Oman. However, signs of continued friction persisted, including precautionary measures involving U.S. personnel in the region and rising market-implied probabilities of potential escalation. Markets also digested President Trump’s State of the Union address, which focused largely on domestic economic policy priorities such as inflation, housing affordability, and healthcare costs, while reiterating a preference for diplomacy with Iran despite maintaining firm red lines regarding nuclear weapons development.
The macroeconomic data flow was relatively modest but remained focused on inflation dynamics. January core producer prices surprised to the upside, marking the strongest monthly increase in nearly four years and raising questions about upstream price pressures feeding into consumer inflation. Meanwhile, consumer confidence improved in February as labour-market perceptions strengthened, while regional manufacturing surveys suggested stable activity with moderating price pressures. Other indicators were broadly neutral, with factory orders declining largely as expected, jobless claims remaining steady, and private payroll estimates continuing to trend higher.
Because the week coincided with the end of the month, February’s broader market picture provides additional context. U.S. equities delivered mixed performance over the month, with the Dow finishing slightly higher (+0.17%) and the Russell 2000 gaining 0.71%, while the S&P 500 declined 0.87% and the Nasdaq dropped 3.38%, marking its weakest monthly performance since March 2025. Much of the weakness was concentrated in large-cap technology as investors reassessed AI expectations and the sustainability of elevated valuations. At the same time, the equal-weight S&P 500 continued to outperform, rising 3.5% for the month and extending its streak of relative gains versus the cap-weighted index to four consecutive months, highlighting a persistent rotation toward a broader set of sectors and companies.
Sector performance for February reinforced that shift. Defensive and commodity-linked areas delivered strong gains, with utilities, energy, materials, consumer staples, industrials, real estate, and health care leading the market. By contrast, consumer discretionary, communication services, technology, and financials lagged as investors reduced exposure to some of the market’s highest-multiple segments. The sector dispersion mirrored broader positioning changes, with capital moving away from mega-cap technology toward cyclicals, defensive sectors, and real-asset exposures.
The corporate earnings season provided a supportive backdrop. With the fourth-quarter reporting period largely complete, S&P 500 earnings growth stands at roughly 14% YoY, marking a fifth consecutive quarter of double-digit expansion and exceeding expectations at the start of the reporting season. However, the average magnitude of earnings beats was slightly below historical averages, suggesting that while fundamentals remain strong, the market’s bar for positive surprises has risen.
Taken together, February’s market action reflected less a broad risk-off move and more a significant internal rotation. Weakness in large-cap technology, renewed debate about the economic implications of AI, and geopolitical uncertainty weighed on headline indices. At the same time, improving market breadth, strong performance in defensives and commodities, and resilient macro fundamentals point to a market environment characterised by dispersion and repositioning rather than deteriorating economic conditions.