Hot inflation. Cold chips. Stay diversified.

by Taylor Topousis, CFA, Market Strategist, Franklin Templeton Institute & Chris Galipeau, Head Market Strategist, Franklin Templeton Institute

Macro

• Economic growth remains strong in the United States. We expect 2026 real GDP growth to come in at 2.5% (based on our Global Investment Management Survey). That is above the Bloomberg consensus of 2.2% and the 2.3% median response from the Federal Reserve’s (Fed’s) most recent Summary of Economic Projections (SEP). The Atlanta Fed’s volatile GDPNow (“nowcasting” model) projects 3.6% GDP growth in the third quarter (Q3).
• The consumer remains resilient. We heard it on earnings calls this week from a number of big banks—the broad message was that the consumer is healthy and supported by a strong labor market, even amid higher gas prices in Q3. Retail sales for September increased 0.8% month-over-month, versus market expectations of 0.3%.
• Initial jobless claims, reported on Thursday, came in slightly below expectations and the four-week average remains below 200,000. This data supports our belief that the labor market remains strong. The September unemployment rate (reported on October 2) was 4.2%.
• Inflation remains hot. Two reports this week came in above expectations. The headline Consumer Price Index (CPI) rose 0.6% in September, an increase from 0.4% in August, and 3.7% year-on-year. The core (excluding food and energy) rose 0.3% and 2.6% annually vs. expectations of 0.2% and 2.5%, respectively. Producer Price Index (PPI) final demand rose 1.3% month-on-month, its largest increase since March of 2022. The core PPI rose 0.7% vs. 0.3% expected, the largest in four years.
• Yields and breakevens spiked following the CPI report. The two-year Treasury yield rose nearly 20 basis points (bps) to 4.95% and the 10-year rose about 13 bps to 5.33%. Between the CPI report and Thursday afternoon, the yield curve has bull-flattened with yields moving lower led by the 10-year, with the yield at 5.08% at the time of this writing. Hot CPI and hot PPI—and yields moved lower?
• Fed rate-hike expectations initially also spiked after the CPI report. Fed funds futures implied a 50/50 chance of an October rate hike immediately after the report, but since then, odds have moved back down to 27%. The market expects three rate hikes between now and December 2027, versus 3.5 hikes immediately after the report. What explains this reaction, despite hot inflation and brent crude oil still trading at $106 a barrel? The answer may lie within equities. Strong capex related to artificial intelligence (AI) has helped drive strong growth in the United States. It has also likely played a role in pushing inflation, and inflation expectations, higher.
• Tech companies have increasingly issued debt to fund their spending plans. Each of these factors may have helped push rates higher over the past year. Changes in the AI spending narrative, even small ones, may have repercussions in the bond market.

Equities

• Some cracks have started to show in areas of the AI trade. Since Tuesday’s close, the Nasdaq 100 Index is down 2%, the Philadelphia Semiconductor Index (SOX) is down over 4%, and the neocloud company Coreweave is down 15%. Since the start of last week (October 5), the SOX is down 11% and the Korean Stock Exchange Index (KOSPI) is down 14%.
• The selloff comes amid questions surrounding the ability of some companies to meet their massive spending commitments over the coming years, their ability to refinance at potentially higher interest rates, and a rapid rise in stock prices for AI-related names (a Bloomberg basket of AI-related stocks is up 30% year-to-date [YTD], and the SOX is up 65%).
• Readers of this note will know that while we are constructive on equities overall (our S&P 500 target range is 7400-7800, based on our Global Investment Management Survey), we also believe we may currently be in a volatility window. We know that historically, markets have been volatile after the Fed begins a new tightening cycle. The median three-month S&P 500 return after the initial hike in the six previous tightening episodes was -3.3%. Despite each period having a drawdown of at least 7% in the year after the first hike, the median 12-month return was 8.1%. The periods with the worst returns were the ones where the Fed moved most aggressively. We do not believe we are entering an aggressive cycle.
• The key theme from our team dating back to January of last year is “broadening.” We believe it is prudent today to stay diversified across size and style in the United States, and that there are opportunities in emerging markets and Japan. Given strong fundamentals in each of these areas, we believe corrections are opportunities to add exposure to the broadening trade.
• Earnings have driven the S&P 500’s 14% rise this year. Earnings estimates have increased while the forward price-to-earnings multiple has contracted from 22x to 20x YTD. Q3 earnings kicked off this week with most of the big banks. Reports were mixed on the headline and showed strength underneath, with banks benefiting from strong capital markets and a resilient consumer. The financials sector has outperformed the S&P 500 by about 3% this past week.
• The earnings calendar shifts to a cyclical/industrial theme next week with major reports coming from aerospace, defense, rail and airline companies. This should give us a good read on the physical economy. The following week will be the big one, with a slew of hyperscaler and tech companies reporting, as well as the October Federal Open Market Committee meeting.
• The two major risks we have been flagging for equities are earnings coming in below expectations and the Fed aggressively raising rates. AI capex expectations, while related to earnings, have also come more into focus for equity investors. We repeat our thinking on the current environment: Stay diversified and stay disciplined.

Fixed Income

• The major story in fixed income this week was the roller-coaster move in Treasuries. The initial selloff after the CPI report Wednesday was short-lived as the tech rout and questions about AI capex contributed to a rally by the end of day Thursday. Ten-year yields moved 15 bps lower this week as of Thursday and currently sit at 5.08%. Our expected range for the 10-year Treasury yield by year-end is 5.0% – 5.5%, based on our survey.
• The primary theme from this newsletter this year as it pertains to duration has been to favor ultrashort and short duration mandates. While we believe that short duration should remain an important structural component of bond portfolios, the move higher in rates has made intermediate- and core/core-plus strategies relatively attractive. We maintain that moves higher in yields can be met with dollar-cost averaging into these areas. For those investors looking for tax-loss harvesting opportunities prior to year end, in our view, fixed income is the area to look. Consider upgrading positions where appropriate.
• Within corporate credit, spreads have widened over the past month, especially in high-yield. The Bloomberg US Agg Corporate option-adjusted-spread (OAS) has increased 8 bps since September 18 and sits at 83 bps today. The Bloomberg US Corporate High-Yield OAS increased 60 bps over the same time frame and currently sits at 324 bps, above its five-year median OAS of 312 bps. Much of the spread movement in high-yield has come from the lowest rung of the index. Given high starting yields and stable fundamentals, we still find upper quality high-yield bonds to be attractive.
• We remain bullish on municipal bonds. Fundamentals remain strong and yields on a tax-equivalent basis are attractive. We believe municipal bonds can serve as a diversifier within portfolios due to their relatively low correlation to both equities and other areas of fixed income.

Sentiment

• Investor sentiment, as evidenced by the latest AAII survey, fell slightly this week. The data released on October 15 shows 39% of respondents were bullish, down from 40% last week. Bearish respondents increased to 42%, up from 39% last week. Neither reading shows signs of excess or capitulation.

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

Source of data (except where noted) is Bloomberg, FactSet and Franklin Templeton Institute, as of October 15, 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.