Category: 2026

3rd Quarter 2026

OUR QUARTERLY NEWSLETTER TO CLIENTS AND FRIENDS OF THE FIRM

THIRD QUARTER 2026

The Upside of Higher Interest Rates

Short-Term Pain, Long-Term Gain

There is an interesting irony in the Federal Reserve raising interest rates. Why does the Fed raise rates? The Fed raises rates to bring down inflation by making borrowing more expensive, while accepting the risk of slowing down the economy as a result.

For investors, that can feel like bad news at first, since bond prices fall when rates rise. Yet for disciplined, long-term investors, higher rates can ultimately be very good news.

Why Own Bonds?

We own bonds for stability. They are the ballast in a diversified portfolio. With the notable exception of 2022 (see Figure 1), in past stock market declines, high-quality bonds have held their value and provided the liquidity to rebalance into stocks when prices were depressed. Bonds are not meant to outperform stocks. Their job is to generate income, preserve capital and dampen volatility so that investors can stay the course.

How Bonds Work

Bonds have a wonderful symmetry. Inflation, historically 2% to 3%, provides an anchor.¹ Short-term bonds pay a bit more than inflation to reward savers for postponing spending, and longer-term bonds add a premium for committing money longer. The result has historically been 10-year Treasury yields of roughly 4% to 5%, not far from today’s levels.² There is nothing extraordinary about today’s rates. What was extraordinary was the ultra-low-rate environment of the past 15 years, a product of the financial crisis, persistently low inflation and pandemic-era intervention.

There is a second symmetry. When rates rise, existing bond prices fall, which is the short-term pain we have felt recently. But as those bonds mature, the proceeds are reinvested at higher yields. Today’s pain sets the stage for better returns tomorrow.

Is the Bond Market Signaling Trouble?

Bond markets have a keen eye for trouble; worries about recession, inflation or default show up quickly in prices. Today we see little such evidence. Futures markets are not pricing an extreme rate environment, and credit spreads, the extra yield investors demand to own corporate bonds rather than Treasuries, remain contained.

Rates could still move higher, but today’s yields look far more like a normalization than a flashing red warning light.

Why We Don’t Buy Long Bonds

This environment also illustrates why we generally avoid long-term bonds. During the third quarter, the Bloomberg U.S. Aggregate Bond Index declined 3.5%.³ As Archimedes observed, “Give me a lever long enough, and I shall move the world.” In the bond market, that lever is duration, which magnifies every move in rates: Treasuries maturing in more than 20 years lost 9% over the same period.⁴ A 20-year Treasury may carry virtually no credit risk, but waiting 20 years while earning a below-market coupon is a very real opportunity cost. We do not believe that extra risk is well compensated. High quality does not mean low volatility.

Stocks Versus Bonds

Finally, higher yields change the most basic decision investors make: stocks versus bonds. Nobel laureate Robert Shiller’s Excess CAPE Yield compares the inflation-adjusted earnings yield of stocks with long-term Treasury yields. In essence, it asks how well investors are being paid to accept the additional risk of stocks. For much of the post-crisis era, ultra-low bond yields made stocks the only game in town.

That has changed. With bond yields substantially higher, stocks no longer enjoy the lopsided advantage they held for most of the past decade, and bonds are once again a legitimate competitor for capital.

For balanced portfolios, that is welcome news. After more than a decade handicapped by low rates, bonds once again offer meaningful income, real diversification and the ballast we want when stocks turn turbulent. Short-term bond losses are never pleasant. But for disciplined, long-term investors, higher interest rates may prove less a problem than an opportunity.

The Thucydides Trap:
A Lesson for Investors

Chinese President Xi Jinping has repeatedly invoked an intriguing historical concept when discussing relations with the United States: the “Thucydides Trap.”

The term comes from the Greek historian Thucydides and his account of the Peloponnesian War nearly 2,500 years ago. A rising Athens was challenging Sparta, the established power, and Thucydides observed that the growth of Athens, and the fear it instilled in Sparta, made war nearly inevitable.

Harvard political scientist Graham Allison brought the idea into the modern era, identifying 16 cases over the past 500 years in which a rising power threatened to displace an established one. Twelve ended in war.

That history makes Xi’s references so interesting, because China’s extraordinary rise increasingly challenges America’s position as the world’s dominant superpower. Xi’s argument is that history need not repeat itself and that great-power competition does not have to end in confrontation. The historical odds are not encouraging, but they are not destiny. The two countries are bound together by trade, capital and supply chains in ways Athens and Sparta never were, and both have far more to lose from conflict than to gain. The trap can be avoided, even if it should not be ignored.

Whatever the outcome, the Thucydides Trap is a useful reminder that economic leadership and geopolitical influence shift over time. For investors, that is a compelling argument for diversification. U.S. markets have enjoyed extraordinary success, but history suggests no country holds market leadership indefinitely. Owning companies across countries and regions allows investors to participate wherever the next generation of global growth emerges.

Thee AI Build-Out Is Becoming the Biggest Economic Bet in U.S. History

Data-center spending is greater than that for the canals, railroads and grid combined—creating jobs and wealth but also boosting inflation.

By Konrad Putzier and Justin Lahart
Sept. 23, 2026 at 9:00 pm ET

The AI build-out is on track to become the biggest economic bet in U.S. history, dwarfing the investments made to fund other huge U.S. infrastructure projects such as the railroads, the highway system and the plumbing for the internet.

Total investment in data centers and related artificial-intelligence infrastructure is projected to total $10.3 trillion from 2025 to 2032, according to new estimates by economist Stijn van Nieuwerburgh published by the Brookings Institution. Th at is a staggering 3.6% of gross domestic product a year, on average. Never before has the U.S. economy been so dependent on the build-out of a single industry.

The investment is transforming every corner of the economy, creating hundreds of thousands of jobs and minting new billionaires.

It is also creating significant risk, as much of it is built on debt. An abrupt slowdown could ignite shock waves throughout the U.S. economy.

Projecting investment is tricky, and total spending might well end up substantially lower. Still, the money poured into data centers this year already represents an investment unprecedented in recent history. AI investment in the U.S. is projected to hit 1.9% of GDP in 2026, according to new estimates from Goldman Sachs. Th e railroad boom of the late 19th century marked the last time the build-out of one new industry accounted for a larger share of the economy.

Here are some important impacts all that money is having on the economy:

Construction

The flood of money spent on the build-out of data centers has represented a bright spot in an otherwise dark time for the construction industry.

Through July of this year, a seasonally adjusted $37 billion has been spent on private data-center construction— about $9 billion more than in the first seven months of last year, according to the Commerce Department.

Private construction spending on everything else—houses, apartment buildings, shopping centers and so on—was about $46 billion below year earlier levels in the first seven months of this year.

Hyperscalers are tying up scarce workers and electricity, raising costs for other businesses. The Federal Reserve Bank of Richmond recently reported that data-center construction is straining labor availability in its area. It isn’t just electricity: In many places, data centers are pushing up land costs. “It’s crowding out manufacturing,” said Didi Caldwell, a site-selection consultant who works with heavy industry.

Financing and risk

Analysts estimate that capital spending at five of the so-called hyperscalers—Alphabet, Amazon.com, Meta Platforms, Microsoft and Oracle—will be $4.2 trillion in the four years ending in 2029, according to FactSet. A growing share of that spending is financed by debt. That level of spending raises risks for the financial sector if the boom goes bust. Van Nieuwerburgh said often tech companies use off-balance-sheet entities to borrow from banks and private-credit firms, and those deals usually come with little public reporting. The practice makes it hard to figure out how great the financial risks are, he added. If AI doesn’t generate enough revenue to service the debt raised to build data centers, the fallout could ripple through the financial system.

Jobs

Economists are divided over whether AI is now meaningfully hurting employment among white-collar workers. What is clear, however, is that the build-out is putting some workers in very high demand. AI was behind more than 750,000 new jobs in the U.S. from 2023 through 2026 to-date, according to LinkedIn estimates. And those jobs pay well: The median salary for AI-related job listings on LinkedIn is around $180,000, compared with $80,000 for all jobs. “It’s one of the robust areas of a very slow labor market,” said Kory Kantenga, LinkedIn’s head of economics for the Americas.

White-collar jobs such as data annotator and AI engineer account for most of the new positions, but employers have also added 117,000 jobs at data centers since the start of 2024. That doesn’t count construction jobs, many of which aren’t permanent.

In the Washington, D.C., area, the number of unionized electricians has risen from 9,000 to 17,500 in recent years, according to Don Slaiman, political coordinator of the trade union IBEW Local 26. “A lot of folks come here to pay off their college debt,” he said. Kwaku Afriyie, 23 years old, has a college degree in cybersecurity and was working in an entry-level IT role when he started worrying about AI taking away his job. Last year he switched careers and became an electrician. Now he assembles components for data centers, making around $30 an hour as an apprentice.

More seasoned workers earn twice that rate. Tyler Beam, 28, has spent most of the past two years building data centers and working for a company that sends prefabricated parts to Amazon data-center construction sites across the country. Most recently, the electrician made $62 an hour, plus overtime. Beam often worked 58 hours a week, sometimes earning double pay. “They want to put them up as fast as possible,” he said. The earnings have boosted his spending: Beam recently bought a GMC Yukon and is house-hunting.

The wealth effect

The AI-powered rally has led to huge gains in stock-market wealth. As of the second quarter, U.S. stock and mutual fund holdings came to $63 trillion, according to the Federal Reserve—nearly double the amount at the end of 2022. The trend has buoyed consumer spending even as inflation-adjusted wage growth has faltered. The gains have been
particularly pronounced for the welloff, who tend to have more of their net worth tied up in stocks than the middle class do.

Nationwide, home sales have been mired in a four-year slump. But in Silicon Valley, AI money is fueling a surge in luxury-home sales. “This is the best it’s been since 2000,” said Ken DeLeon, a real-estate agent. DeLeon recently listed a five-bedroom home for $9.9 million. He got seven offers, and within two weeks it was in contract for more than $13 million. The winning bidder: an AI entrepreneur.

Appeared in the September 24, 2026, print edition as ‘U.S.’s AI Build-Out Is on Track As Biggest-Ever Economic Bet’.

Disclosures: Past performance is no guarantee of future results.
1: US Bureau of Labor Statistics CPI.
2: US FRED Data 1953-Present.
3: AGG ETF return Q3 2026.
4: TLT ETF return Q3 2026.
Figure 1: Data courtesy of Bloomberg, consisting of the Bloomberg US Intermediate Treasury Index vs the S&P 500 Index for notable time periods of negative equity performance since 2000. For illustrative purposes only.

October 20, 2026
2nd Quarter 2026

OUR QUARTERLY NEWSLETTER TO CLIENTS AND FRIENDS OF THE FIRM

SECOND QUARTER 2026

IPO Exuberance and Picking Winners

Few financial events this year generated more excitement than the SpaceX IPO—a fitting occasion to revisit former Federal Reserve Chairman Alan Greenspan’s famous warning about “irrational exuberance.” Greenspan coined the phrase in 1996 to describe the excessive optimism surrounding internet stocks. Many dismissed his comments at the time, yet history proved him correct when the NASDAQ Composite ultimately lost nearly 80% of its value in the dot-com collapse. His warning, however, arrived more than three years before the market peaked—a reminder that enthusiasm can persist far longer than fundamentals alone might justify.

Identifying a revolutionary technology is
often far easier
than picking
the winners

An Initial Public Offering is the first time a privately held company offers shares on a public exchange, typically to raise capital or to provide liquidity for founders, employees, and early investors. From an investment perspective, however, an IPO is primarily a financing event for the company and a liquidity event for existing shareholders—not necessarily a chance for new investors to buy at an attractive valuation. Decades of academic research bear this out: on average, newly public companies have underperformed the broader market by roughly 1% over their first year.¹

Underwriters also have strong incentives for an offering to be viewed as a success. To stimulate demand, shares are often priced modestly below what institutional investors expect to pay, creating the familiar “first-day pop.” While this generates positive headlines, much of that initial appreciation is captured by institutions that receive allocations before most individuals can participate.

SpaceX appears to be no exception. In the first few days on the market, shares surged to more than $200 per share before retreating toward their initial trading price of around $120 today. Meanwhile, the company’s narrative has broadened from space exploration to AI infrastructure, satellite communications, and space-based computing. At its IPO price, SpaceX traded at an extraordinarily high multiple of revenue despite inconsistent profitability. Investors are effectively valuing what the company could become over the next decade rather than what it earns today.

SpaceX’s expanding ambitions point to a deeper lesson. Firms that once had little connection to artificial intelligence now routinely position it at the center of their strategy, a reminder that identifying a revolutionary technology is often far easier than picking the winners that will ultimately profit most from it. Consider the early internet. Numerous web-browsers competed for dominance, including Lynx and Netscape, yet the company that became one of the greatest technology success stories was Google, who was neither the first browser nor an early entrant. More importantly, many of the internet’s largest economic winners were simply businesses that learned to use the technology more effectively than their competitors.

The same dynamic may unfold with artificial intelligence. Today’s AI developers understandably receive most of the attention, but tomorrow’s biggest winners may instead be companies that deploy AI to automate operations, improve customer experiences, reduce costs, or accelerate scientific discovery. Pharmaceutical firms discovering breakthrough drugs, manufacturers optimizing production, and financial firms improving productivity may ultimately generate greater shareholder value than some of the companies building the underlying technology.

Artificial intelligence is a revolution that stands to change society as profoundly as the internet before it. Still, many of that era’s pioneers have come and gone. Whether the anticipated public debuts of leaders like Anthropic and OpenAI ultimately reward long-term shareholders remains, as always, an open question.

Successful investing does not depend on identifying the next headline-grabbing IPO or predicting a revolution’s winners with concentrated bets. History continues to support a disciplined approach built on broad diversification, thoughtful asset allocation, tax efficiency, and long-term ownership of exceptional businesses.

THIS QUARTER’S WINNER

This quarter’s best-performing asset class was one many investors overlook entirely: Emerging Markets.

Two of the largest countries within Emerging Markets—Taiwan and South Korea—have become indispensable participants in the global AI revolution. From advanced semiconductor manufacturing to memory chips and critical hardware infrastructure, these economies sit at the center of the technology supply chain powering artificial intelligence worldwide.

Last year, a meaningful portion of international outperformance resulted from a declining U.S. dollar. This quarter, however, geopolitical uncertainty surrounding the conflict with Iran has strengthened the dollar as investors sought traditional safe-haven assets. Despite that currency headwind, Emerging Markets continued to produce exceptional returns.

Year-to-date, Emerging Markets have appreciated more than 20%, another reminder of why we advocate globally diversified portfolios. While the U.S. market remains near all-time highs, leadership within global markets continually rotates, and no one can consistently predict which region will lead next.

Diversification is not simply about reducing risk. Increasingly, it is proving to be a powerful source of longterm investment returns.

Stock Gains Without All the Taxes? How the Hottest Trade on Wall Street Works.

The stock-market surge has propelled the use of a new kind of tax-loss harvesting. We break it down.

By Miriam Gottfried & Peter Santilli
May 16, 2026 at 7:00 pm ET

With the stock market near record highs, it isn’t enough to be winning anymore. Wealthy investors are now obsessed with losing, too.

The hottest investment on Wall Street promises a magical-sounding mix of both: Index-beating performance that also comes with losses to off set capital gains taxes.

Millions of investors are sitting on big gains in concentrated stockholdings, be they shares of Magnificent Seven tech giants, plain-vanilla index funds or employee shares of hot tech companies.

The traditional move would be to turn to direct indexing, a form of tax-loss harvesting that has been an investing mainstay since the early 2000s. There is now $1.1 trillion invested in that strategy, according to research firm Cerulli Associates.

But for many investors who have ridden this ebullient stock market, direct indexing is no longer generating the losses it once did.

So financial advisers are trying to turn up more losses for their clients by employing strategies that use leverage. Over $150 billion has flowed into this newer breed of tax-loss harvesting, known as long-short tax-aware, or tax-aware alpha, according to Brent Sullivan, who writes about the industry on his Substack, Tax Alpha Insider.

The strategy comes with some risks for investors.

If the S&P 500 is up 15% for the year, the goal is for the client’s portfolio to rise that much, while also distributing losses. These losses could be used to offset gains in highly appreciated securities elsewhere in the portfolio.

How the long-short strategy works

An investor with $10 million would go to a long-short manager who would invest the money in a basket of stocks. But they would also
borrow against the investment to create two “extensions,” longs that bet on the stocks and shorts that bet against them.

In a 140-40 portfolio, for example, the manager would be going long and short by an additional $4 million, respectively.

The investment is now 140% long and 40% short, which can amplify returns, while providing more opportunities for tax losses to harvest.

The investor’s net exposure would still be $10 million, or 100% net long.

The leverage amplifies both the losses and the gains relative to the investor’s overall position. It also generates losses on the shorts that go up in addition to the longs that go down, so there is greater potential for losses to harvest.

But direct indexing gradually loses steam as a method of generating losses as the market continues to rise. Around half of such portfolios industrywide are now “ossified,” meaning they are no longer generating losses, estimates Jon Diorio, head of U.S. wealth product at BlackRock.

A new strategy took shape. Hedgefund firm AQR Capital Management developed the tax-aware long-short strategy for clients such as family offices and ultrawealthy individuals. Around five years ago, the firm and its rival, Quantinno Capital Management, began allowing individual investors and their advisers to tailor the strategy inside their own separately managed accounts, or SMAs.

Custodians, most notably Fidelity Investments, made the strategy accessible by lowering the investment minimums. It was a hit. AQR now manages nearly $70 billion in taxaware long-short strategies, roughly 80% of which is in SMAs. Quantinno manages more than $48 billion. They have spawned numerous imitators.

Long-short managers generally aim for “alpha,” meaning they want to outperform the benchmark in addition to harvesting losses. The strategy must balance these aims.

The strategy has become so popular that Fidelity and Charles Schwab have recently instituted limits on new accounts.

Both strategies come with risks. Direct-indexing managers might not succeed in tracking the index if they can’t find appropriate substitutes for the stocks they sell. The Internal Revenue Service’s “wash sale” rule limits the ability to recognize a loss on the sale of stock if the same stock is purchased within 30 days before or after the sale.

But holding on to the winners means new gains can build up over time within the strategy. Investors must eventually pay taxes on these if they cash out.

Michael Paulus, founder of wealth manager PCM Encore, recommends direct indexing for nearly all his clients, particularly those close to retirement who will need to sell highly appreciated stocks to fund it. Direct-indexing managers charge annual fees as low as 0.05%.

But he is more cautious about using long-short SMAs. He has used them for clients expecting a major onetime gain such as from the sale of a business or for clients who work in tech and get a large portion of their pay in stock. He otherwise avoids them.

Tax-aware long-short strategies can cost as much as 1.5% to 3%, including investment management, financing and borrowing fees.

“All else being equal, I’d probably rather cut the government a check than a hedge fund in Connecticut,” Paulus said.

Neither direct indexing nor longshort SMAs are likely to eliminate all capital gains in a bull market like this one. The losses they generate are often used to offset gains in other areas of the portfolio. For example, someone selling a stake in a business at the beginning of the year could invest the money into a long-short SMA to generate losses to offset some of their capital gains by the end of the year.

Disclosures: Past performance is no guarantee of future results.
1: Dimensional – Do IPOs Have a Place in Your Portfolio? September 2025

July 16, 2026
1st Quarter 2026

OUR QUARTERLY NEWSLETTER TO CLIENTS AND FRIENDS OF THE FIRM

FIRST QUARTER 2026

Energy Shocks & Market Resilience

War is among the most devastating forces humanity experiences. Yet history shows us that even in the shadow of conflict, society rebuilds, innovation continues, and economic progress resumes often sooner than many expect.

The first quarter of 2026 offered investors another familiar reminder: markets are noisy but resilient. Since the conflict with Iran began, growth has moderated, inflation has risen, and while recent signals suggest an end may be near, risks remain.

The most tangible risk of the current conflict involving Iran is through energy prices, which ripple across transportation, manufacturing, and consumer goods. If you’ve filled your car with gasoline recently, you’ve felt the rise in energy costs firsthand. Even so, futures markets suggest the spike in oil prices may be temporary. Contracts expiring as soon as next year are trading under $70 a barrel, down from a high of $112.95 on April 7th, indicating that market participants expect energy prices to normalize over time.¹

long-term success
rarely depends
on identifying a
single winner

Despite these pressures, equity markets have recovered from their short-lived drawdown earlier this year, and many clients have been pleasantly surprised by their Q1 results. While US tech companies have ceded their spot as top performers, international and emerging markets delivered strong results and our alternative investments provided measurable diversification benefits during a period of uncertainty. This reinforces a core principle: long-term success rarely depends on identifying a single winner, but rather on maintaining exposure to many sources of return.

The relationship between oil prices and stock returns is less intuitive than it seems: despite repeated oil price surges over the past 50 years, the data shows no consistent pattern of weak stock returns in the periods that followed. Figure 1 illustrates this by showing the returns of the S&P 500 Index compared to the price of oil over time. Rather than being coupled to the price of oil, the stock market relies more on total economic growth.

Technology remains a key driver of that growth. Artificial intelligence is reshaping industries from healthcare to manufacturing, and the opportunity extends well beyond a handful of high-profile companies. The expansion of the broader infrastructure of data centers, semiconductors, power generation, and network capacity continues to drive growth both at home and abroad.

As we move further into 2026, the landscape appears neither euphoric nor fragile. Growth is steady, corporate earnings continue to expand, and interest rates are supportive without being artificially low. These conditions may lack drama, but they provide a durable foundation for long-term investors.

Our commitment remains unchanged: thoughtful planning and portfolio management, clear communication, and disciplined focus on the principles that have guided successful investing for generations: diversification, patience, and perspective.

PRIVATE CREDIT
VS. THE PRESS

Recent headlines have drawn comparisons between today’s private credit markets and 2008. Those comparisons may garner attention, but they aren’t supported by the facts. The current environment reflects adjustment, not crisis.

Private credit is central to the U.S. economy. Middle-market companies, the primary borrowers, number roughly 230,000 firms and employ about 40 million people, nearly one-third of all U.S. corporate employment. This is a foundational source of business investment and job creation, not a peripheral corner of finance.

Much of the concern centers on software companies, which represent about 24% of the private credit market, and their vulnerability to AI disruption.² Yet many of these businesses operate on long-term contracts with recurring revenue, meaning any performance adjustments are likely to unfold gradually rather than suddenly.

Redemption gates, or predefined limits on investor withdrawals, have also drawn scrutiny. Rather than being warning signs, these limits are prudent risk-management tools that prevent forced asset sales and protect portfolio value for all investors. Risk in this asset class is best measured by default rates, not headlines. Current credit losses sit at approximately 2.5% per year, broadly in line with historical norms³.

Risks will always exist in investing. Although vigilance is warranted, the evidence today is clear: current default rates are far from concerning, liquidity is available, and private credit markets are functioning as designed. Rather than running for the hills, we’ll continue to closely monitor these assets and evaluate opportunities in the context of your entire portfolio.

Disclosures: Past performance is no guarantee of future results.
1: US Crude WTI Future September 2027 contract valued at $69.74 as of 4/17/26 and historical price of the contract on 4/7/26. 2: JPM IB North American Credit Research, Proskauer, Latest as of March 2026. 3: Wall Street Journal, Private Credit’s Exposure to Ailing Software Industry Is Bigger Than Advertised 3/29/26. Figure 1: For illustrative purposes only. Data sourced from Bloomberg. Chart compares the Bloomberg Crude Oil Historical Price Index to the S&P 500 Index, monthly from 1/1/70-3/31/26.

War in the Middle East
Challenges Global
Financial Stability

Markets have been broadly orderly so far—
but financial stability risks are elevated

By Tobias Adrian

Global financial markets entered 2026 from a position of strength. Asset prices rose across major markets, volatility was subdued, and financial conditions were easy by historical standards. That benign backdrop has now been tested by the war in the Middle East.

So far, markets have absorbed the shock with a degree of resilience. While the decline in asset prices has been significant, market functioning has been orderly. Nonetheless, this resilience should not be taken at face value. Rather, it reflects cycles of escalation and de‑escalation, structural improvements in the financial system, and the absence of a decisive adverse turn that would trigger sustained market drawdowns.

Repricing, orderly market functioning

Global markets reacted swiftly following the outbreak of hostilities. Equity prices declined, sovereign bond yields rose, and volatility increased across asset classes, reflecting higher energy prices and renewed inflation uncertainty. Importantly, this adjustment was reasonably orderly, without signs of acute liquidity stress or funding problems among financial institutions and investors. In fact, this price‑based absorption of shocks is a key feature of resilient markets. It facilitates risk sharing across investors and preserves price discovery critical for efficient capital allocation. So far, short‑term funding markets and core market infrastructures have helped facilitate the repricing of assets.

Financial conditions have tightened since the onset of the conflict, but they remain far from the stress levels observed during past episodes of global turmoil. Compared with earlier crises, there is still a considerable margin of safety. At the same time, the relatively modest adjustment to date also indicates that markets have not fully priced adverse scenarios.

Inflation as a transmission channel

The main channel through which the conflict has affected markets has been via inflation expectations. Higher energy prices have pushed breakeven inflation rates and yields up across advanced and emerging economies. Yield curves have flattened, with short‑term rates rising more than long‑term rates. This highlights the difficult environment facing central banks. With near‑term inflation risks having risen substantially, monetary policy must remain focused on price stability. On the other hand, the longer the war continues, the more damaging it is to economic growth and labor markets—the flattening of the yield curve, should it continue, could be a sign of this. In this environment, clear communication, credibility, institutional independence, and timely tightening when warranted are essential to anchoring expectations.

Spotlight on emerging financial vulnerabilities

Higher yields have renewed focus on public debt risks. Many advanced economies are entering this episode with elevated debt levels and limited fiscal space. Together with changes in the investor base—away from central banks and toward price‑sensitive nonbank investors—sovereign yields may respond more forcefully to inflation shocks than in the past.

Emerging markets are more sensitive to these changes. Elevated pre‑shock valuations and the growing dominance of debt portfolio flows and carry‑trade strategies have increased exposure to global risk sentiment. While resilience has improved over the past decade in many countries, vulnerabilities remain pronounced in those with high external financing needs or volatile investor bases.

Amplification mechanisms

The key financial stability risks do not lie in the initial shock itself, but in amplification channels that could turn market volatility and sell-offs into more acute stress. Elevated leverage in parts of the nonbank financial sector, increased concentration in equity markets, and historically tight credit spreads all raise the potential for abrupt forced-selling and sudden liquidity strains through margin and collateral calls.

Private credit is an important area of focus. Rapid growth in direct lending has made the sector more important to the overall economy and financial system, while opacity, valuation practices, short‑term funding backed by longer‑term assets, and rising defaults pose challenges. While these vulnerabilities have not yet been tested by an adverse shock, their presence means that the system is more exposed, even if markets have remained orderly so far.

Policy space: constrained, but differentiated

In addition to monetary policy, other key policy areas also have uneven space to act. Fiscal policy is limited by high debt and persistent deficits. By contrast, financial stability policy is less constrained. Central banks have reduced their balance sheets, freeing some capacity for asset purchases if needed, and crisis‑management frameworks and liquidity backstops are stronger than in the past. Targeted prudential measures, robust supervision, effective stress testing, and well‑designed liquidity tools can also be deployed.

Prepare, don’t predict

The experience of recent months underscores that resilience should not be inferred from the absence of stress. Elevated asset prices, intact risk‑taking incentives, and stronger amplification channels mean that risks remain skewed to the downside—even if markets have adjusted in an orderly manner so far.

The task for policymakers is therefore not to predict the next shock, but to ensure that vulnerabilities are mitigated and the system remains capable of absorbing stress without amplifying it. Amid recurring supply shocks and heightened geopolitical uncertainty, financial stability cannot be taken for granted—it must be actively protected.

This blog is based on Chapter 1 of the April 2026 Global Financial Stability Report, “Global Financial Markets Confront the War in the Middle East and Amplification Risks.”

April 22, 2026