Q3 2026 Market Recap & Q4 Outlook: Rates, Oil and the Midterms

In our view there is still plenty to be optimistic about. First, rates are rising on the back of a strong economy and an oil-driven bout of inflation – not because there is runaway inflation that we are trying to catch up to. Second, although painful now, we expect inflation will pass as energy prices (ultimately) normalize. And third, the economic strength underneath all the volatility and headlines looks durable as S&P 500 profits are growing, unemployment has held in a tight 4.1% – 4.3% range since March, and households and businesses are still spending.

And as a silver lining, the surge in yields has created a genuine opportunity for investors holding cash that need income: high-quality bonds now offer yields above 5% that can be locked in for years rather than reset every time the Fed moves (more on this in Timely Topics).

As we think about the final quarter of the year, there are two things on our minds.

1. What happens to rates from here. The Fed signaled one more hike this year, but in our view the case for it is weaker than that signal suggests. Core inflation, which strips out food and energy, has held near 2.5%, which tells us most of the pressure is coming from oil rather than the broader economy. And as of this writing, the September jobs report showed hiring slowing sharply, with just 29,000 jobs added and July revised to a loss. We think the Fed is closer to the end of this hiking cycle than markets fear, with oil (i.e. Iran) as the deciding variable. If the Strait reopens and crude falls, we think the case for a second hike fades quickly.
2. The midterm elections. On November 3, voters will decide control of the House and Senate, and we think this election carries more risk than markets are pricing. As of this writing, Democrats look poised to gain seats, though we’d describe it less as a “blue tide” and more of a blue undertow, with the gains coming from voters unhappy with the status quo and looking for change. History offers comfort to the optimists: since 1946 the S&P 500 has averaged a gain of roughly 16% in the six months following a midterm election, and going back to the late 1930s it has been higher 12 months later about 95% of the time.

Our approach heading into November and year-end reflects both outcomes. We are reviewing hedging strategies for a post-election environment, recognizing that hedges carry costs and tradeoffs and that any changes depend on each client’s circumstances and tolerance for risk. At the same time, we suggest using today’s yields to put excess cash to work in high-quality bonds, which pay a real income in either scenario. Longer term we remain constructive on equity markets, as earnings continue to deliver, but are cognizant that near-term rates and political risk will keep volatility elevated.

The Economy and Markets: Oil, the Fed, and Bond Yields in Q3 2026

• The S&P 500 set a record, but the path there was anything but smooth. Stocks came under pressure in July, rallied in August as small caps and the equal-weight S&P 500 joined large caps at new highs, then narrowed sharply as Treasury yields surged in September. In our view the late-quarter narrowing was a rates story more than a verdict on the economy, which is why we wouldn’t abandon small and mid caps after one rough month.
• The Fed raised rates for the first time since July 2023. After a nine-month pause, the Fed voted unanimously on September 16 to lift its target range 0.25% to 3.75% – 4.00%, with Fed Chair Warsh saying inflation “is too high and has been for too long.” Its projections point to one more hike this year. The Fed’s next decision comes October 28, less than a week before the midterms, which puts monetary policy and politics in the same headlines right as pre-election volatility typically peaks.
• The economy is running hotter than headline GDP suggests, but hiring is cooling. Second-quarter GDP grew 2.2%, while final sales to private purchasers, which strips out volatile trade, inventory, and government swings, grew 4.6%, the fastest pace since early 2023. The labor market is the one area showing fatigue, with September payrolls well below expectations. We think consumer spending and hiring are now the two data points that matter most, because they decide whether higher rates slow the economy or simply cool it.

TIMELY TOPICS

The 10-Year Treasury Crosses 5%: What It Means for Bonds

On September 25 the 10-year Treasury closed above 5% for the first time in 19 years. Yields rose across the entire curve, with the 5-, 7-, and 10-year each up more than 0.8%, right in the intermediate range most bond portfolios own. The drivers all pointed the same way: a strong economy, $100 oil, a hiking Fed, and federal debt that just passed $40 trillion.

While prices of fixed income went down, yields went up, and the broad bond aggregate now yields 5.6%. Cash has paid well too, but cash yields reset the moment the Fed changes direction, while a bond bought at 5% keeps paying 5% (until maturity). There’s also a timing angle: in a typical midterm cycle, Treasury yields have drifted lower in the months after the vote as policy uncertainty fades, which argues for locking in today’s levels rather than waiting.

In the current environment we see the biggest opportunity in municipal bonds. Munis sold off harder than taxable bonds this quarter (-6.3% versus -3.5% for the Aggregate), which pushed their yields up faster (see Exhibit 5). The muni index now yields 4.5%, which works out to a tax-equivalent yield above 7.5% for investors in the top federal bracket, well above what taxable bonds of similar quality pay. For high earners holding bonds in taxable accounts, that is the most compelling after-tax income high-quality bonds have offered in years, and residents of high-tax states like California can add state tax savings on top through state-specific funds.

We suggest portfolios use this move rather than run from it, gradually extending excess cash into high-quality intermediate bonds, leaning on munis in taxable accounts, and staying selective in high-yield, where the weakest borrowers are already showing strain. It changes the equity math too. At 19.1x forward earnings, the S&P 500’s earnings yield of about 5.2% is now roughly level with the 10-year, which makes the bond allocation a genuine competitor for capital for the first time in a long while.

Q4 2026 Investment Outlook: What to Watch

The fourth quarter will likely bring more volatility as markets weigh the path of interest rates, the midterm elections, and the durability of corporate earnings. Yet underneath these uncertainties, the economic backdrop remains relatively resilient, and we continue to see opportunities across both equities and fixed income.

For investors, the opportunity created by higher bond yields may prove to be one of the more important developments of 2026. We favor selectively extending duration, emphasizing high-quality fixed income and tax-efficient municipal bonds where appropriate, while maintaining disciplined equity exposure and evaluating hedges around near-term risks.

If companies keep delivering through higher borrowing costs, we think the record highs will continue to be earned. But with a contested election a real possibility, we’d rather be prepared for both a sharp rally and a sharp drawdown than bet on either (see Stu Strasner’s recent piece on a Midterm Election Like No Other).

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