2026 Fall Outlook

Resilience Under Pressure: Navigating Higher Rates, Inflation, and the AI Boom

Tim Hoyle, Chief Investment Officer
thoyle@haverfordquality.com

Entering the final months of 2026, investors are navigating a market environment increasingly shaped by a sequence of interconnected forces. Geopolitical tensions are keeping energy prices high. Rising oil and diesel prices are contributing to persistent inflation pressures. Elevated inflation is keeping the Federal Reserve (Fed) hawkish and contributing to higher Treasury yields.

Despite these headwinds, the U.S. economy continues to demonstrate resilience. High gas prices and slumping sentiment have yet to deter consumers from spending. Earnings remain strong across a broad array of companies and sectors, and the AI investment boom continues to provide meaningful support to economic activity. Strong earnings growth has propelled the market higher even as valuation multiples have contracted. Two of the key challenges investors face are whether the current level and growth of earnings are sustainable and whether the data center buildout will introduce greater cyclicality.

Significance of 10-Year Treasury Yields above 5%

The most important development in financial markets may be the significant move in the U.S. 10-year Treasury yield above 5% to reach levels not seen in over 20 years. In his recent remarks, Fed Chair Kevin Warsh cited three reasons for rising yields: geopolitics, which is one of the driving forces behind high oil prices; stronger-than-expected economic growth; and increasing competition for capital as hyperscalers issue debt to finance the AI infrastructure race. For years, economists have speculated whether increased government borrowing would crowd out private investment. Now, the reverse seems true. Voracious private sector demand for credit by AI issuers is possibly crowding out other borrowers.

Comparison of U.S. Treasury Yields and 30-Year Fixed-Rate Mortgages

September 30, 2025 – September 25, 2026

A sustained rise in the 10-year Treasury yield above 5.25% may pose several risks for financial markets and the economy. Not only do borrowing costs rise, potentially slowing housing activity, capital spending, and economic growth, but higher yields can increase the discount rate applied to future cash flows, placing downward pressure on equity valuations. Equities should be able to withstand higher yields as long as earnings growth remains robust, but investors should be on notice that the risk-reward landscape is becoming marginally less favorable. If inflation continues unabated, yields continue to rise, or earnings begin to deteriorate, Treasuries may compete more directly with stocks for investor capital.

An Inflation Battle on Two Fronts

The Fed usually fights price pressures on one of two fronts: overcoming supply-side disruptions or battling overheating demand. Currently, the Fed is contending with both issues as geopolitics are contributing to an energy-related supply shock while demand for AI componentry is spiking.

AI Capex Boom: Growth Engine or Inflation Driver?

Artificial intelligence is the defining economic theme of this cycle. The scale of the AI buildout is unprecedented as it is on pace to become the largest infrastructure investment wave in U.S. history. According to J.P. Morgan, hyperscaler capital expenditures (capex) could exceed $800 billion in 2026, which is approximately 10 times the amount spent in 2019.¹  Economist Stijn van Nieuwerburgh estimates that spending on data centers and related AI infrastructure could reach $10.3 trillion between 2025 and 2032, equivalent to an extraordinary 3.6% of U.S. gross domestic product (GDP) annually.²

Major U.S. Infrastructure Project as Average Annual % of GDP

As of September 25, 2026

The AI investment surge is supporting economic growth, but it is also creating substantial demand for labor, power, commodities, and financing. This extraordinary demand is contributing to inflationary pressures that are proving difficult for policymakers to ignore.

Import Prices for Computers, Peripherals, and Semiconductors

% Change from a year earlier; January 1, 2023 – August 31, 2026

Surging Oil Prices

On the supply side of the equation, geopolitical events have constrained oil supplies and refining capacity, with prices again hovering around $100 per barrel. Diesel costs have moved even more dramatically, reaching record highs amid refinery outages and low inventories. Additionally, rising U.S. exports to Europe are limiting domestic supply. High gasoline prices impact consumers directly, but the impact of surging diesel prices may be more extensive, given diesel’s importance as a key input in shipping, agriculture, construction, and other industries.

U.S. Diesel Prices

$/gallon; January 1, 2022 – October 1, 2026

Monetary policy has its limitations. While rate hikes can dampen demand, monetary policy cannot create additional refining capacity or lower geopolitical risk. Fortunately, despite rising yields and oil prices, inflation expectations remain relatively contained, suggesting investors are not yet pricing in a lasting inflation spiral. The Fed would like to keep it that way, evidenced by the September rate hike. As Fed Chair Warsh stated in his September press conference, “We aim to ensure that credit and financial conditions are consistent over time with our mandate, that relative price changes in some sectors of the economy do not broaden, that inflation compensation in market prices stays low, and that inflation expectations remain well anchored.”

U.S. 10-Year Breakeven Inflation Rate

%; 10-Year Treasury Securities vs. 10-Year Treasury Inflation-Indexed Securities; September 24, 2024 – September 25, 2026

Is the Market Underestimating the Fed?

The September Fed meeting delivered an important message: policymakers still view financial conditions as accommodative, suggesting that additional rate hikes may be necessary to create the restrictive conditions required to bring inflation back to target. Presently, the economy appears capable of withstanding higher rates because many of today’s key growth drivers—most notably AI-related investment and infrastructure spending—are less sensitive to borrowing costs. At the same time, the Fed has become less transparent. Rather than relying on explicit forward guidance, market participants will need to make assumptions for themselves. Based on the two-year Treasury trading at nearly 5%, the market has announced that more Fed rate hikes are likely coming.

Election Uncertainty and Market Volatility

Election years often create uncertainty, and 2026 is unfolding largely as expected. Uncertainty rises as investors debate potential policy changes, including taxes, fiscal spending, regulation, trade, and geopolitics. As uncertainty rises, market volatility typically follows.

Markets often struggle to price political outcomes before they are known. Once the election outcome becomes clearer, however, investors usually shift their focus back to fundamentals. While the House will almost certainly flip to a Democratic majority, the odds for the Senate remain 50/50. A Democrat Congressional majority is likely to bring headline risk to the AI buildout, however, we believe that data center builds will ultimately continue largely unabated.