August 2026 Market Commentary

August 17, 2026

• US and Iran peace plan falls apart.
• 2Q GDP slows to 1.5%.
• Fed holds rates steady at July FOMC meeting.
• July Returns: S&P 500 -0.1%. Bloomberg US Aggregate Bond index -1.3.%

July had a certain déjà vu quality to it as the year’s dominant themes- the Middle East, inflation, artificial intelligence (AI), and Fed policy- remained intact. Though there were new developments with each, none changed dramatically. In the Middle East, the US and Iran appear to remain as far apart as ever on reaching a longer-term peace deal. Artificial intelligence, by turns, continues to excite investors about its potential and spook them about the vast sums of money being spent to develop it. Inflation remains elevated due primarily to higher energy prices but has shown signs of abating. And at the Fed, the changing of the guard, with new Chair Kevin Warsh, has put upward pressure on rates while injecting uncertainty about the longer-term path of monetary policy.

Equity markets experienced elevated volatility in July, not readily apparent by the S&P 500’s negligible decline. AI-related stocks were particularly volatile as highlighted by the Philly Semiconductor Sector index (SOX), consisting of companies primarily involved in the production of semiconductor chips, which briefly fell into bear market territory at month end. The 20% decline reflected investor concerns about the potential returns, or lack thereof, on the large sums of money being spent on AI infrastructure. The collapse of a large hedge fund investing in AI stocks and the release of a new Chinese AI model, also placed additional downward pressure on the sector. However, illustrating how quickly sentiment can shift, the SOX index rebounded 18% in the first week of August, aided by various corporate earnings reports pointing to continued strong demand for AI chips and other equipment required for the AI infrastructure buildout.

From a broader market perspective, July marked the second consecutive month in which more than half of the S&P 500’s underlying economic sectors outperformed the overall index, indicating a wider market rally not dependent upon any one sector, e.g. Technology, to drive results. The broadening was supported by strong second quarter earnings reports with eight of the 11 economic sectors recording double-digit growth. According to industry group FactSet, consolidated earnings growth for the second quarter is expected to be 50%, the strongest since 2Q21. Excluding Alphabet and Amazon, whose earnings benefitted from large, unrealized gains on equity securities, consolidated earnings growth is forecasted to be 32%, marking the seventh consecutive quarter of double-digit earnings growth, the longest such stretch since 2017-2019.

For the month, large caps (S&P 500) fell 0.1%. Small caps (Russell 2000) fell 3.1% hurt in part by rising interest rates. International market returns were mixed with developed markets (MSCI EAFE) up 1.9%, while emerging markets (MSCI EM) fell 3.3%.

July was a difficult month for bond markets, as rising inflation fears and uncertainty around Federal Reserve policy drove Treasury yields sharply higher. The 10-year Treasury yield climbed from roughly 4.47% at the start of the month to 4.74% by July 31, a move of nearly 27 basis points that translated into meaningful price losses. For the month, the Bloomberg US Aggregate Bond index, the broadest measure of the US bond market, shed 1.3%, its largest monthly decline since March. The selloff was fueled by a string of hotter-than-expected economic data reports, including the employment cost index and PMI readings, reinforcing the view that inflation remains stubbornly above the Fed’s 2% target. Continued volatility in oil prices and the daily grind of Middle East headlines added another layer of inflationary pressure that kept bond markets on edge.

The Federal Reserve’s July Federal Open Market Committee (FOMC) meeting was the defining event of the month. As expected, the Fed opted to hold interest rates steady, however, the decision was met with dissension by three members and a fair amount of pushback from the market. Markets reacted sharply to the decision. Longer-dated Treasuries sold off further with the 30-year yield surging past 5.20% for the first time since 2007. The three policymakers who dissented from the decision, did so in favor of a 0.25% rate increase arguing that modest rate hikes are needed to prevent inflation from becoming entrenched.

At his post-meeting press conference, Warsh commented that “Nominal and real yields are materially higher…some of the increases in market interest rates between FOMC meetings are among the most significant in decades”. This comment, and the rest of his press conference, led many to believe he was using the market sell-off as both indicating but also addressing inflation – creating a more restrictive environment – and thus an equivocation. While the short end of the Treasury curve tightened to remove built-in hike premiums, the continued and significant sell-off at the long end of the curve following the meeting looked like a rebuttal to Warsh’s assurance that inflation would be addressed by the Fed.

July was particularly harsh for the municipal bond market with the Bloomberg Municipal Bond Index falling 1.7%, the worst July performance for the asset class since 2003. Munis underperformed Treasuries on a relative basis: the 10-year muni-to-Treasury yield ratio rose to roughly 70.7% by month-end, up from 64.7% a month earlier, an indication of munis cheapening significantly relative to government bonds. A heavy new-issuance calendar compounded the pressure, overwhelming demand at a time when the broader rates market was already under stress. This was particularly poignant as July is historically a strong month for muni investors with strong reinvestment dollars and positive returns.

Outside of financial markets, Middle East, developments followed a predictable pattern. Hopes for a lasting peace, fostered by the signing of a Memorandum of Understanding between the US and Iran in mid-June, were quickly dashed in early July as the two sides quarreled over control of the Strait of Hormuz. Iran’s insistence that it alone should be in control led to another round of US military strikes, which in turn led to additional retaliatory strikes by Iran against US military facilities throughout the Middle East. Despite several pronouncements by US officials towards month end suggesting a plan to reopen the Straight was imminent, there was scant evidence to corroborate those statements as traffic through the vital passage remained severely constricted.

Macroeconomic data pointed to mixed conditions, with 2Q26 GDP growth slowing, employment weakening, and inflation moderating, while remaining well above the Fed’s longer-term 2% target.

Employment unexpectedly declined in July as nonfarm payrolls shed 23K jobs vs. the consensus forecast for 85K job additions. In addition, May and June were revised down by a combined 103K, suggesting labor markets faltered heading into the summer. Despite the job losses, unemployment fell from 4.2% to 4.1% aided by a decline in the labor force participation rate which fell to its lowest level since February 2021. In another sign of cooling labor market conditions, average hourly earnings growth slowed from 3.4% to 3.2%, the slowest pace since May 2021. In addition, job openings in June fell nearly 200K to 7.36M, a three-month low.

On a headline basis, second quarter GDP growth of 1.5% underwhelmed vs. the consensus forecast, and first quarter pace, of 2.1%. Compared to the first quarter, a downturn in government spending and reduced AI spending contributed to the deceleration in growth. Importantly, consumer spending increased to 3.2%, aided in part by tax refunds which, according to the IRS, were 11% larger on average compared to 2025. Business spending also remained healthy, increasing 3.0%, driven by a 15% increase in equipment spending. The underlying details of the report suggested the economy remains healthy despite the modest headline number.

Inflation showed small signs of further improvement in July as headline consumer inflation (CPI) rose just 0.1% from June, aided by a 1.5% decline in energy prices. Compared to a year ago, prices rose 3.4%, down from June’s 3.5% pace. Core CPI, excluding food and energy, rose 0.2% for the month and 2.5% from a year ago, matching January and February for the slowest annual pace since 2021. Producer inflation cooled more than expected in July, suggesting further near-term relief for consumer prices. In aggregate, the two inflation reports, combined with the weaker 2Q GDP report and July employment report, helped relieve near-term pressure on the Fed to raise rates. After reaching 80% in late July, market odds for a September rate hike now stand at ~40%.

Trade reemerged in the headlines in July, after being absent for several months, as President Trump announced new tariffs ranging from 10-12.5%, on 60 trading partners saying they had failed to adequately enforce a ban on goods made using forced labor. The tariffs, which took effect at the end of July, effectively cover all imports entering the US and replace 10% stop gap tariffs Trump implemented after the Supreme Court invalidated his April 2025 tariffs earlier this year. Unlike prior tariffs which had statutory expiration dates, the new tariffs, justified under different laws, do not. Separately, Trump announced a 50% tariff on ~$20B of Canadian goods, set to take effect in late August.

Conclusion: On the surface, the S&P 500’s small decline suggested relative calm in July. However, beneath the surface, AI-related stocks faced elevated volatility as investors increasingly shift their attention from excitement for all things AI, to execution risk, as companies deploy massive sums of money on AI infrastructure. A welcomed broadening of market leadership beyond a handful of mega cap technology stocks helped buoy broader market performance. Higher interest rates, stemming from elevated energy prices, continued concerns about inflation, and uncertainty surrounding future Fed monetary policy actions weighed on fixed income returns. Economic data suggested the economy remains healthy, but slowing labor market conditions bear watching.

Trust, estate planning, insurance, and investment products are not a deposit, not FDIC insured, not insured by any federal government agency, not guaranteed, subject to investment risks, including possible loss of the principal amount invested and may go down in value. Any information and research contained herein do not represent a recommendation of investment advice to buy or sell stocks or any financial instrument nor is it intended as an endorsement of any security or investment, and it does not constitute an offer or solicitation to buy or sell any securities or investment services. This content is for informational purposes only and does not constitute legal or tax advice. Please consult your legal or tax advisor for specific guidance tailored to your situation. First Western Trust Bank cannot provide tax advice.