Who’s Right? Two-Year Yields or Two-Year Breakeven Rates?

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 main drivers of our GDP forecast are the continued capital expenditures by big tech to build out artificial intelligence (AI) infrastructure, and the resilient consumer. Solid jobs data this week from the JOLTS report and the Purchasing Managers’ Index (PMI) data suggest the economy is strong. The latest nonfarm payrolls (for June) came in at 57,000, versus consensus expectations of 113,000. The unemployment rate declined from 4.3% to 4.2%. May’s payrolls figure was revised down from 172,000 to 129,000.
We are watching the inflation picture closely. As I am writing this, oil is trading at $68 a barrel, down 43% from its highs earlier in the year. This should serve to take some pressure off the Fed to make any policy moves in the near term. Our core Personal Consumption Expenditures forecast for the year is 3.0% - 3.5%; it rose 3.4% as of May 2026. Historically, US two-year note yields are a strong predictor of what the Fed will eventually do. If the two-year yield is above the effective fed funds rate, the bond market is telling us the Fed needs to raise rates. Right now, the two-year yield stands at 4.17%, 50 basis points (bps) over the effective fed funds rate. So that would call for two rate hikes. Fed fund futures now have one-and-a-half 25-bps hikes priced in for December. However, breakeven rates tell a completely different story.
Breakeven inflation rates have completely collapsed. One-year breakeven rates are now at 1.43% (down from 5.50%), the lowest level since October of 2024. Two-year breakeven rates are also back to October of 2024 levels, closing at 1.98% (down from 3.50%). Finally, five-year breakeven rates are currently 2.26%, also back to where they were in October of 2024. The bond market seems less concerned about inflation, and the five-year number is basically at the Fed’s 2% target. These numbers represent the bond markets’ pricing of annualized inflation out one, two and five years. I’m not sure what to make of this conflict right now, so I’ll keep monitoring the situation and report back as it evolves.
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 $101.38, breaking out from a one-year base. This move is strongly against the consensus of a weaker dollar and slightly against our range-bound forecast, with $100 at the top of that range.

Equities

We are constructive on US equities and have established a target range of 7400 - 7800 for the S&P 500 Index, driven by 15%+ year-over-year (Y/Y) earnings per share (EPS) growth. First-quarter earnings exceeded consensus expectations, which have served to drive the S&P 500’s 2026 earnings estimate to $341 today, up from $310 at the start of the year. Earnings season begins in about two weeks, and this will be the next big catalyst for the tape. (See Franklin Templeton Institute’s Global Investment Management Survey for more on earnings and our forecasts.)
We reiterate our “broadening” call on equities and emphasize our bullish call on US small- and mid-cap stocks, and we continue to favor emerging market equities and equities in Japan. Earnings estimates have steadily ticked up all year and I’ll repeat: earnings drive stock prices in the long run—not geopolitics.
I’d argue we are seeing some signs of excess in the market that I want to flag. For example, Citadel is reporting a retail “frenzy” for exposure in the semiconductor space, as reported by Bloomberg. In June, retail traded roughly $1.9 billion of semi options premium a day. That is 6x their historical average, with 75% of the options traded being call options. Trading $1.9 billion in option premium is a measure of option cost and is also the potential max loss of those contracts. That 6x historical average is astounding, and the heavy tilt toward call options represents speculation.
Additionally, Citadel reported that leveraged exchange-traded fund (ETF) assets reached a record of $218 billion. Since the end of March alone, assets have increased by roughly $82 billion (+60%) led by technology (+136%) and semiconductor (+$175%) exposures. One out of every three listed options traded in the United States now expires on the same day.
The Wall Street Journal reported that the combination of increased retail use of margin with the rush into levered ETFs. US margin debt rose 54% to a record $1.4 trillion in May from a year ago, per FINRA.
Dispersion continues within the indexes. In the S&P 500 Index, 231 stocks are outperforming the index year to date (YTD), while 191 stocks are down on the year. In my view, this sets up an ideal environment for stock selection and, for some investors, tax-loss harvesting at the same time.
If you look at the S&P SmallCap 600 Index you see the same dispersion pattern. In this index, 248 stocks are outperforming the index YTD, but 180 are down on the year.
As of this writing, the Equal Weight S&P 500 Index, representing the “average stock,” is at a new all-time high. The S&P MidCap 400 Index is at a new all-time high. The Russell 2000 Index is at a new all-time high. The Russell 1000 Value Index is also at a new all-time high.
Bringing up the rear so far this year is the vaunted Magnificent Seven basket, which is down 1.74% YTD as of this writing. The basket may very well still end up in the green in 2026 if it can sustain a rally, though it is about 10% behind the S&P 500 Index YTD.
This massive underperformance in Mag Seven has probably gone too far, in my estimation. These stocks, collectively, are now as oversold as they have been in five years, based on technical indicators. The relative strength index on the basket is 28.7. As such, these stocks are technically oversold and may be worth a look. Fundamentally, the Mag Seven basket is trading at 22x 2027 EPS estimates. EPS growth, all in, is +20% Y/Y in 2027 vs 2026. The price-to-earnings-to growth (PEG) ratio is about 1. It looks like a good time to buy, in my view.
Bottom line: We think it’s prudent to have a diversified equity playbook that includes large-, mid- and small-cap exposure in the United States with a balance of growth and value. Large growth is on sale here. The same can be said for ex-US equity exposure: emerging markets and Japanese stocks look attractive. Our takeaway is to reduce concentration and spread one’s bets. Consider using any further consolidation to an advantage.

Fixed Income

We expect the 10-year US Treasury bond yield in the range of 4.25% - 4.75% for the year. The last trade was 4.48%, as of this writing. We think duration risk is attractive toward 4.75%.
The US yield curve has flattened 40 bps since February. The 2-year/10-year spread is now 30 bps. This is a function of two-year yields moving higher (10-year yields have been well-behaved).
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 is attractive.
Credit spreads have made big moves (tightening) in the last two months. Investment-grade (IG) spreads, as proxied by the Bloomberg US Corporate 1-3 year Option-Adjusted Spread (OAS) are now only 42 bps over comparable Treasuries. IG spreads are a few bps from five-year tights. High-yield spreads, as proxied by the Bloomberg US Corporate HY OAS, are now 270 bps over, moving up slightly on the week.
We are bullish on munis and find taxable-equivalent yields to be attractive along with robust fundamentals. Importantly, municipal bonds offer potential diversification benefits relative to most taxable fixed income mandates. Consider using some cash to add muni exposure in taxable accounts. Have a read of our latest piece, “Municipal bonds are back.”

Sentiment

The percentage of bullish investors in the latest AAII survey dropped to 31%, from 45% last week. The percentage of bearish investors in the AAII survey moved up to 42% from 36%. No signal here but complacency sets in when the percentage of bulls trades north of 50%. Something to keep an eye on. Bull markets peak on euphoria. I don’t think we are there yet, but I am on watch.

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 June 25, 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.

Glossary of terms

The AAII (American Association of Individual Investors) Sentiment Survey: This survey offers insight into the opinions of individual investors by asking them their thoughts on where the market is heading in the next six months.

Breakeven rates: The difference between yields of Treasury bonds and TIPS for issues of the same tenor/maturity, calculated by subtracting TIPS yields from Treasuries; a measure of inflation.

Call option: A call option is an agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity or other instrument at a specified price within a specific time period.

Capital expenditure (capex): Funds that companies spend to acquire, upgrade or maintain physical assets, such as buildings, technology or equipment, with the purpose of maintaining or growing future operations.

Duration: A measure of how much a bond’s price changes relative to changes in interest rates.

Fed funds (FF) rate: The interest rate that depository institutions such as banks charge other institutions for holding overnight reserves.

Leveraged ETF: A type of exchange-traded fund which is designed to track an underlying index, asset or commodity while amplifying its daily performance using leverage, typically two or three times the daily return. Short-term gains as well as losses can be amplified.

Magnificent Seven: Refers to shares of Apple, Microsoft, Amazon, Alphabet, Meta Platforms, Nvidia and Tesla.

Margin: Margin refers to borrowed money that is used to purchase securities.

Relative Strength Index (RSI): A momentum indicator that measures the speed and magnitude of recent security price changes, used in technical market analysis.

Option-adjusted spread (OAS): Measures the spread between a bond's interest rate and the risk-free rate, while adjusting for any embedded options like callable or mortgage-backed securities.

Price/Earnings-to-Growth (PEG) Ratio: Financial metric to determine a stock's true value by dividing its standard P/E ratio by its expected earnings growth rate.

Tape: A reference to broad market performance, based on the ticker tape that transmitted stock prices during the 19th and 20th centuries.

Taxable-equivalent yield: The yield of a municipal bond investment calculated to reflect the benefits of income tax exemption and to be comparable to the yield of a taxable bond.

Yield spreads/tights: Spreads are the difference between yields on differing debt instruments of varying maturities, credit ratings, issuers or risk levels. “Tights” in reference to spreads indicates small differences in yields.

Indexes

Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator of future results.

Bloomberg US Corporate High Yield Index: Tracks the performance of the USD-denominated, high yield, fixed-rate corporate bond market.

Russell 1000® Value Index: A market capitalization-weighted index that measures the performance of Russell 1000® Index companies with relatively lower price-to-book ratios and lower forecasted growth rates.

Russell 2000® Index: A market capitalization-weighted index that measures the performance of the 2,000 smallest companies in the Russell 3000 Index.

S&P 500® Index (SPX): A market capitalization-weighted index of 500 stocks, a measure of broad US equity market performance.

S&P 500 Equal Weight Index (EWI): The equal-weight version of the S&P 500 Index. The index includes the same constituents as the capitalization weighted S&P 500, but each company is allocated a fixed weight, or 0.2% of the index total, at each quarterly rebalance.

S&P MidCap 400® Index: A market capitalization-weighted index of 400 stocks of mid-size companies, distinct from the large-cap S&P 500.

The S&P SmallCap 600 Index: A market-value weighted index comprised of 600 domestic stocks chosen for market size, liquidity and industry group representation.

US Dollar Index: A basket of six foreign currencies (euro, Japanese yen, UK pound sterling, Canadian dollar, Swedish krona and Swiss franc) used to track the relative strength of the US dollar, with a higher index value representing US dollar strength.

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