Macro
The macro backdrop shifted towards a more stagflationary regime during the week as renewed Middle East tensions, higher energy prices and additional US tariffs reversed the recent disinflation narrative. Headline growth remains resilient, but increasingly concentrated in AI investment and higher-income consumption, while rising inflation risks have shifted the focus of central banks from easing towards preserving inflation-fighting credibility.
A temporary 48-hour pause in US military action against Iran allowed Brent crude to retrace from almost USD 100/bbl to below USD 90/bbl by week-end. Nevertheless, disruption risks across the Strait of Hormuz and Red Sea shipping remain elevated, leaving an energy risk premium embedded in markets. Global bond markets reacted accordingly, with UK 10-year gilt yields remaining above 5%, German Bund yields reaching their highest level since 2011 and US 10-year Treasury yields briefly approaching 4.7%, reflecting renewed inflation concerns.
June US inflation data remained constructive, with softer core CPI and contained producer prices suggesting underlying price pressures continue to moderate. However, higher energy prices, delayed tariff pass-through and resilient labour markets increase the risk that inflation reaccelerates over coming months despite the recent improvement in headline data.
The Federal Reserve enters this week’s FOMC meeting facing a more difficult policy trade-off. Markets continue to expect rates to remain unchanged, but policymakers must balance encouraging inflation data against renewed upside risks from energy prices and tariffs. The ECB similarly left rates unchanged while signalling that a September hike remains the most likely outcome should inflation pressures persist.
Trade policy also became increasingly inflationary. The US administration maintained its 10–12.5% baseline tariffs across roughly 60 economies supplying almost all US imports, while signalling additional measures including a potential 50% tariff on Canadian goods, 25% tariffs on parts of Brazilian imports and future tariffs on pharmaceutical products. Financial markets largely viewed the package as an extension rather than a new shock, but around half of affected businesses have yet to fully pass higher costs through to consumers, suggesting further inflationary pressure and margin compression remain ahead.
Flash PMIs remained consistent with continued global expansion, although the surveys largely predated the latest rise in oil prices and therefore may understate the impact of higher energy costs on business sentiment.
Overall, the macro backdrop remains characterised by resilient but increasingly narrow growth, with AI investment offsetting weakness across housing and other interest-rate-sensitive sectors. At the same time, higher energy prices, expanding tariffs and delayed cost pass-through have shifted the balance of risks towards a more persistent stagflationary environment, reinforcing the likelihood that central banks maintain restrictive policy for longer.
Rates
The rates market underwent a decisive hawkish repricing, marking a transition from “the Fed is probably finished” to “the Fed may need to tighten again, possibly immediately.” Fed funds futures moved to price roughly two additional rate hikes by January, while the implied probability of a surprise July hike increased from below 10% to around 35–40%. The shift reflected a combination of Brent crude approaching USD 100/bbl, renewed tariff-related inflation risks, resilient AI-driven capital expenditure and electricity demand, a still-tight labour market and reduced forward guidance under Chair Kevin Warsh, leaving markets increasingly reliant on incoming data and market pricing rather than explicit Fed communication. At the same time, the recent surge in energy prices has made inflation data increasingly noisy, reducing the effectiveness of a purely data-dependent policy framework and reinforcing a hawkish risk-management bias unless geopolitical tensions ease materially.
US Treasury yields rose across the curve, with the 2Y continuing to signal tighter policy expectations while the 30Y yield remained above 5% for 13 consecutive sessions (28 sessions year-to-date), its longest such stretch since 2007 despite the Fed funds rate remaining roughly 150 bp below its pre-GFC peak. Importantly, the sell-off reflected both higher expected policy rates and a rising term premium, as investors demanded greater compensation for persistent inflation, elevated Treasury supply, fiscal uncertainty and weaker bond-equity diversification. Rather than a traditional recessionary flattening, both the front and long end repriced simultaneously as markets questioned whether inflation could sustainably return to the Fed’s 2% target amid energy pressures, tariffs and continued AI-related investment. Financial conditions are also tightening unevenly: housing, consumer credit and government financing costs are increasingly constrained by higher yields and mortgage rates, while investment-grade credit spreads remain contained and AI-driven corporate investment continues to support broader financial conditions.
In Europe, the ECB left policy rates unchanged but maintained a clearly hawkish bias, with President Lagarde confirming that some Governing Council members favoured an immediate hike while leaving September firmly in play should inflation risks persist. The ECB’s communication increasingly suggests that the burden of proof has shifted towards delaying, rather than justifying, further tightening, with markets pricing around 44 bp of additional hikes by year-end absent a meaningful improvement in the energy outlook. UK gilts also came under pressure after comments from the new government suggesting greater flexibility within fiscal rules revived concerns over fiscal discipline, highlighting that higher energy prices, defence spending and sovereign issuance continue to place upward pressure on developed-market bond yields. Going into the July FOMC meeting, the key question is no longer simply whether the Fed hikes, but whether tighter policy would successfully re-anchor long-term inflation expectations or merely tighten already rate-sensitive sectors while leaving largely supply-driven inflation pressures unresolved.
Credit
Credit markets remained resilient at the index level but increasingly dispersed beneath the surface. US IG spreads widened to 78bp (widest since early May) while yield-to-worst reached 5.47%, a fresh YTD high, reflecting higher Treasury yields rather than unusually attractive credit spreads. IG funds recorded $7.1bn of weekly outflows, including a record $8.2bn single-day withdrawal, while long-duration IG underperformed HY as investors repriced duration and refinancing risk. Despite weaker technicals, fundamentals remain sound, with 29 US rating upgrades versus 23 downgrades and defaults still exceptionally low. The market is increasingly rewarding issuer selection over broad credit beta.
AI financing remained the dominant credit theme. Expected AI CapEx continues to approach $800bn–1tn, while AI-related debt issuance has already exceeded $300bn globally this year. Although AI exposure still represents only ~4% of IG and ~3% of HY, markets now expect a record $2.25tn of US IG issuance in 2026, raising concerns over future supply rather than credit quality. Nearly 80% of recently issued hyperscaler bonds trade wider than at issuance despite superior ratings, as investors demand greater compensation for duration, supply concentration and uncertain monetisation. Some strategists now see IG spreads widening towards 100bp over the next six months if issuance continues at the current pace, increasing the value of active security selection, collateral quality and structural protection.
Private credit continued to stabilise as redemption requests moderated, although liquidity gates and subdued inflows continue to expose the structural mismatch between semi-liquid vehicles and illiquid loans. Stress remains concentrated in highly leveraged software borrowers facing AI disruption, floating-rate debt, weak interest coverage and fewer refinancing or exit opportunities, while businesses with durable cash flows continue to access financing. Data-centre credit remains supported by long-term contracts with investment-grade counterparties, although permitting, power availability, construction costs and residual-value risk are becoming increasingly important underwriting considerations. Primary markets remained open despite greater selectivity: Netflix issued $1bn with 3.6x order coverage (vs 10x previously), Kuwait successfully raised $6bn despite regional tensions, and banks led US IG issuance for a second consecutive week, reinforcing that the banking sector remains a source of credit rather than systemic risk. Overall, headline spreads remain tight, but higher government yields, record AI-related supply and rising refinancing costs continue to drive meaningful dispersion beneath the index.
Equities
US equities pulled back this week as technology and consumer discretionary stocks led the decline, extending the recent rotation away from high-multiple growth. The S&P 500 (-0.61%), Nasdaq Composite (-2.13%), Dow (-0.35%) and Russell 2000 (-1.09%) all finished lower. However, the equal-weight S&P 500 (-0.30%) outperformed the cap-weighted index, suggesting the weakness remained concentrated in the largest AI and growth stocks rather than reflecting broad-based selling across the market.
Sector performance reinforced this rotation. Energy (+3.75%) led gains, followed by Utilities (+2.48%), Industrials (+1.77%), Real Estate (+1.35%), Materials (+1.24%), Health Care (+0.90%), Information Technology (+0.43%) and Financials (+0.14%). Communication Services (-6.15%) and Consumer Discretionary (-6.10%) were by far the weakest sectors, while Consumer Staples (-1.37%) was the only other sector to finish lower. The sector performance highlighted continued investor preference for defensives, cyclicals and AI infrastructure beneficiaries over high-multiple consumer internet and communication services companies.
The week’s best performers reflected continued strength in AI infrastructure, industrials and defence. Super Micro Computer (+26.3%) rallied on renewed AI infrastructure optimism, while Westinghouse Air Brake (+17.3%), International Paper (+16.3%), Dell Technologies (+14.7%), Lockheed Martin (+14.3%), SLB (+13.0%), Digital Realty (+13.0%), United Rentals (+12.7%), Smurfit Westrock (+12.6%) and Packaging Corp (+11.4%) all posted double-digit gains. At the other end of the spectrum, Tesla (-15.3%) was the week’s weakest performer following a significant earnings miss, followed by Rollins (-13.8%), MSCI (-11.9%), Alphabet (-9.2%), Palantir (-8.9%), Uber (-8.6%) and DoorDash (-8.5%), highlighting broad profit-taking across high-multiple AI and consumer internet names.
Q2 earnings season accelerated meaningfully, with roughly 24% of S&P 500 companies reporting and 88% beating EPS estimates, the highest beat rate in five years. Despite strong aggregate results, the market reaction remained notably muted, reflecting a shift in investor focus away from earnings beats towards AI economics, capital intensity and free cash flow. Over the past year, higher AI CapEx was generally rewarded as evidence of accelerating demand. This earnings season suggests investors are increasingly questioning whether rising infrastructure spending will ultimately generate attractive returns, whether frontier models possess durable competitive moats and whether increasingly capable low-cost Chinese models could trigger a broader price war across the model layer. The debate has therefore shifted from “how much should companies invest?” to “how much economic value will those investments ultimately create?”
This shift was most evident in Alphabet, which reported Q2 EPS of $9.11 on $119.8bn of revenue, while Google Cloud revenue surged 82% YoY to $24.8bn, comfortably exceeding expectations. Under last year’s market narrative, these results and management’s decision to raise 2026 AI CapEx guidance from $190bn to $205bn would likely have been viewed positively. Instead, investors focused on negative free cash flow of $5.9bn, driven by accelerating AI investment, sending the shares sharply lower despite exceptional operating performance. Tesla experienced a similar reaction. Revenue exceeded expectations at $28bn, but EPS of $0.33 missed consensus ($0.51), while CapEx increased to $5.8bn, pushing free cash flow to negative $1.1bn for the first time in two years. Investors also focused on margin pressure following a 67% decline in regulatory credit revenue, resulting in one of the week’s largest share price declines. Together, Alphabet and Tesla reinforced the market’s growing preference for AI monetisation and capital discipline over AI investment alone.
Elsewhere, earnings reinforced that AI infrastructure demand remains exceptionally strong but that expectations have become increasingly demanding. Intel delivered its strongest revenue growth in more than 15 years, driven by 59% YoY growth in data-centre revenue, with EPS and revenue comfortably exceeding expectations. However, investors viewed the strong quarter largely as a direct consequence of elevated hyperscaler AI spending rather than evidence that concerns over AI CapEx had eased. GE Vernova reported 22% revenue growth, 88% growth in orders and increased its backlog to $176bn, while raising full-year guidance. Nevertheless, the shares declined as management’s guidance increase fell short of elevated whisper expectations following the stock’s exceptional rally. Similar patterns emerged across Texas Instruments, ServiceNow and IBM, where generally solid results were met with muted or negative price reactions as investors increasingly demanded evidence of accelerating returns rather than simply resilient operating performance. By contrast, companies delivering clear operational leverage and improving fundamentals, including United Rentals, Digital Realty, Roper Technologies and much of the financial sector, materially outperformed. Financials remained one of the strongest reporting groups, with banking EPS beats running 13-0 and financial services 15-0, while Danaher disappointed on weaker bioprocessing demand, dragging the life sciences complex lower. Overall, the earnings season reinforced that markets are becoming significantly more selective, rewarding companies demonstrating tangible AI monetisation, productivity gains and free cash flow generation while increasingly penalising businesses where rising AI investment has yet to translate into higher returns on invested capital.
The week’s price action highlighted an important shift in market leadership. The first phase of the AI rally rewarded companies directly supplying compute, particularly GPU designers, semiconductor equipment and memory manufacturers. The current phase is becoming increasingly differentiated as investors distinguish between AI infrastructure providers, AI monetisers and companies simply increasing spending. Alphabet’s results reinforced that AI demand remains exceptionally strong, but also confirmed that investors are no longer willing to reward CapEx alone. Higher infrastructure spending must now be accompanied by accelerating cloud growth, enterprise adoption and visible improvements in free cash flow and returns on capital. The market reaction therefore reflected changing investor preferences rather than deteriorating AI fundamentals.
At the same time, the competitive landscape continues to evolve rapidly. Chinese frontier models, including Moonshot AI’s Kimi K3 and Alibaba’s Qwen, demonstrated that China is increasingly competing not only on lower inference costs but also on frontier model quality despite relying primarily on export-restricted, previous-generation GPUs. This reinforces the view that future AI economics will be determined by the interaction between three variables: rapidly expanding token demand, falling cost per token and enterprise efforts to optimise AI spending. While frontier models increasingly resemble a commoditising layer with leadership changing almost weekly, this does not necessarily weaken the infrastructure thesis. Lower inference costs should accelerate enterprise adoption, while sovereign AI, enterprise deployments and agentic AI continue to expand structural demand for GPUs, networking, memory, storage, power and data-centre capacity.
The earnings season also reinforced that the AI investment theme is broadening well beyond hyperscalers and semiconductors. Industrials, power infrastructure, data-centre REITs, equipment rental companies, defence contractors and selected financials materially outperformed, reflecting the widening economic impact of AI infrastructure investment. Strong performance from United Rentals, Digital Realty, Caterpillar, GE Vernova and defence names suggests investors are increasingly rotating towards second- and third-order beneficiaries rather than concentrating exposure exclusively within the Magnificent Seven. Looking further ahead, software companies capable of demonstrating measurable productivity gains and enterprise AI monetisation, including workflow automation and agentic AI platforms, are likely to become the next leg of the AI investment cycle as infrastructure spending increasingly translates into enterprise earnings growth.
Overall, this week’s market action supports the view that the AI cycle is entering a more mature phase rather than ending. Hyperscaler CapEx continues to move higher, sovereign AI investment is only beginning, enterprise adoption continues to broaden and infrastructure bottlenecks across memory, networking, power and data centres remain unresolved. However, equity markets are becoming significantly more selective. The next stage of performance is likely to be driven less by multiple expansion and more by execution, monetisation, free cash flow generation and returns on invested capital. The investment opportunity is therefore broadening across the AI ecosystem, but increasingly requires security selection rather than simple exposure to the AI theme.