Chris Galipeau: Operation Twist

by Chris Galipeau, Head Market Strategist, Franklin Templeton Institute

Macro

• Our real gross domestic product (GDP) forecast for 2026 is 2.5% (based on our Global Investment Management Survey) versus the Federal Reserve’s (Fed's) forecast of 2.2% and the Wall Street consensus of around 2%. The economy remains resilient and the consumer is strong. The only thing that could throw us a curveball would be a policy mistake by the Fed. We do not anticipate that. I hesitate to even mention this because the data whips around so fast I don’t glean much from it, but the latest Atlanta Fed GDPNow forecast sits at 4%.
• Next week we have a handful of economic data points. The core Personal Consumption Expenditures (PCE) price index is probably the most important for markets, followed by jobless claims. All eyes are on Jackson Hole, Wyoming, as the Fed meets there for its economic symposium August 27-29.
• Our core PCE forecast for the year is 3.0%–3.5%; the June reading was 3.3%.
• The two-year Treasury note yield stands at 4.19%, still about 50 basis points (bps) over the federal funds rate, but off the boil. Remember, the bond market leads the Fed, not the other way around.
• US Treasury Secretary Scott Bessent seems to have brought back “Operation Twist” with the move to buy long bonds last week. The nominal dollar amount is not significant (US$2 billion), but this could be a signaling event for markets. As our Head of Research Larry Hathaway noted to us, the risk is that the peashooter becomes a bazooka. Our Senior Market Strategist Rick Polsinello also notes that the additional US$2 billion will begin in early September and continue for months to “improve liquidity”—Bessent’s words, not Rick’s.
• Breakeven rates have moved higher. One-year breakeven rates are 1.85%, up 20 bps on the week. Two-year breakeven rates are 2.25%, up 13 bps on the week, and five-year breakeven rates are 2.30%, up 8 bps. These numbers represent the bond markets’ pricing of annualized inflation out one, two, and five years. Breakevens are still at odds with the message from two-year yields, but they are beginning to converge higher. This data can and does change very quickly. As I have said many times before, I am not sure how to rectify these seemingly opposite signals. Two-year notes say hike rates while breakeven rates say maybe not.
• Meanwhile, the fed funds futures market is indicating there is a 35% chance of a 25-bps hike in September and a 38% chance of a hike in December. This data moves very fast, so this picture can and will change quickly depending on incoming data.
• On the currency front, we are expecting the US dollar to be essentially flat for the year despite the recent volatility. The US Dollar Index is trading at 98.76, lower following the “Operation Twist” announcement but still firmly rangebound as it has been for the past 17 months.

Equities

• We are constructive on US equities and have established a year-end target range of 7400-7800 for the S&P 500, driven by 15+% Y/Y earnings-per-share (EPS) growth. Second-quarter (Q2) earnings season is over, with the exception of market-mover NVIDIA, which reports results on August 26. All in, earnings power has been very strong in the first six months of the year. Consensus expectations for 2026 now sit at $363.20, up 23% year-over-year (Y/Y). For 2027 the consensus earnings estimate is $406.23, representing a 12% Y/Y growth rate versus 2026. (See Franklin Templeton Institute’s Global Investment Management Survey for more on earnings and our forecasts.)
• Bloomberg reports that in Q2, 25 firms in the S&P 500 Index have quantified the use of artificial intelligence (AI) on their income statements, saying that on average they have seen 180 bps of margin growth. This is the first inning of hearing about AI impact, I suspect. Meaning, going forward I’d expect we hear more companies quantify the impact of AI on their businesses. Accretive to margins is bullish.
• If we assume the consensus earnings estimates are reasonably correct, that puts the tape at 21.22x this year’s earnings and 18.97x 2027 estimates. The long-term historical forward multiple is about 17x. Portfolio managers are now focusing their efforts on corporate earnings power for calendar year 2027. I can’t make a strong argument that the tape is “cheap” here, but I also can’t make the argument that a 18.97x forward multiple is crazy rich either—unless bond yields move significantly higher. We don’t expect that, but that is a risk. What would Bessent do if this happens?
• Here’s the next thing I’m thinking about: The concept of peak rate of change in earnings growth. Not peak earnings power in dollars, but peak rate of change Y/Y.  Just looking at consensus estimates for the S&P 500 out to 2028, the data says 2026 is the peak Y/Y rate of change. If this is accurate, I’d expect a higher level of volatility going forward.
• Speaking of rising volatility, take five minutes to read our latest white paper on what to expect from equities. Our Market Strategist Lukasz Kalwak and I provide you with a look at seasonal volatility, midterm election years, liquidity, fundamentals, and what we historically see in the third year of the presidential cycle. Don’t miss this piece: “Broadening Delivered. Now Prepare for Volatility.”
• The tape is recognizing broad fundamental strength. Consider this: The cap-weighted S&P 500 Index is up 13.40% year-to-date (YTD) through August 19, and the S&P 500 Equal Weight Index is up 16.99%. The S&P 400 MidCap Index is up 17.23% and its equal-weighted version is up 15.94%. The Russell 2000 Index is up 23.21% and its equal-weighted version is up 21.70%. No single name is dominating. Everything is participating.
• Bottom line: We think it’s prudent to have a diversified equity playbook that includes US large-, mid- and small-cap exposure with a balance of growth and value. The same can be said for ex-US equity exposure; emerging markets and Japanese stocks look attractive. That involves reducing concentration and spreading one’s bets. We favor buying on pullbacks.

Fixed Income

• We expect the 10-year US Treasury bond to yield in the range of 4.25%–4.75% for the year. As of this writing, the last trade was 4.68%. We think adding duration risk makes sense around 4.75% or so. Polsinello tells us that core and core plus strategies should get closer looks, should rates remain elevated.
• The US yield curve is flat on the week. The two-year/10-year spread is now 50 bps, unchanged from last week.
• We expect short duration fixed income mandates and corporate credit to outperform cash again this year. Considering our views on US 10-year yields, we do not expect duration to be a significant driver of total return this year. Rather, all-in yield capture seems to be the play, although recent spread widening might create an opportunity for additional total return. Clipping coupons looks attractive.
• Credit spreads remain well behaved in the face of higher yields. Investment-grade spreads, as proxied by the Bloomberg US Corporate 1-3 Year Option-Adjusted Spread (OAS), are now 46 bps over comparable Treasuries. Investment-grade spreads are still only a few basis points from five-year tights. High-yield spreads, as proxied by the Bloomberg US Corporate HY OAS, are now 270 bps over. These are both relatively tight levels from a historical perspective, reflecting a strong fundamental backdrop with corporate profitability being the main driver.
• We are bullish on municipal bonds and find taxable equivalent yields to be attractive, along with robust fundamentals. Importantly, municipal bonds can offer potential diversification benefits in the form of low correlations to various equity markets, relative to most taxable fixed income mandates. The market is on pace for another year of record supply; however, tight spreads in taxable bonds have helped the markets absorb these high supply levels.

Sentiment

• The percentage of bullish investors in the latest AAII survey (the week ending August 19) is 36%, a low reading. The percentage of bearish investors in the AAII survey is 40%. The wall of worry is still in place.
• Bull markets peak on euphoria. I don’t think we are there yet.

I will continue to analyze the markets and will offer insights again next week.

Source of data (except where noted) is Bloomberg and Franklin Templeton Institute, as of August 20, 2026. Important data provider notices and terms are available at www.franklintempletondatasources.com.

The Franklin Templeton Institute Global Investment Management Survey is a biannual outlook survey designed to give a view across our investment teams. The Franklin Templeton Institute identifies the median across the survey answers and develops the outlook. The survey received responses from around 200 portfolio managers, directors of research and chief investment officers, representing participation across equity, private equity, fixed income, private debt, real estate, digital assets, hedge funds and secondary private markets. Each of our investment teams is independent and has its own views.

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