Equities Rebound in Q2 as Commodities Decline and Fed Turns Hawkish

The S&P 500 Index posted its strongest quarter since 2020, rebounding sharply after a weak Q1. While high inflation, conflict in the Middle East, and hawkish central banks remained in focus, strong corporate earnings likely bolstered investor confidence, pushing the index to new all-time highs.

Earnings were strong across multiple sectors, with 83% of S&P 500 companies reporting over the quarter beating on earnings and 74% of those companies beating on revenue. The labor market showed resilience, with three consecutive Nonfarm Payrolls prints reflecting the addition of 465k jobs (prior to revisions), more than double analyst estimates. Businesses invested heavily in growth initiatives, particularly in Artificial intelligence (AI). Semiconductor value chains and industrials both benefited from the investment.

Encouragingly, gains were more widely spread across style, geography, and sector than they were in Q1, creating a balanced rally. Investor confidence likely improved as easing geopolitical tensions and lower energy prices (in the second half of the quarter) bolstered risk assets, pushing equity markets higher.

While Q1 reflected a strict bifurcation between value and growth styles, Q2 was more balanced, with U.S. growth stocks modestly outperforming value as tech rebounded and attention shifted back to artificial intelligence, technological innovation, and long-term growth trends. While technology remained a key driver, market gains were ultimately driven by a wider range of sectors.

In particular, Industrials delivered solid returns, bolstered by datacenter infrastructure spending and continued defense demand. Consumer Discretionary, Financials, Real Estate, and Healthcare all posted positive gains while Energy and Utilities declined amidst easing oil prices and rising yields.

International equities kept pace with the S&P 500 this quarter (the MSCI ACWI ex-USA Index gained 14.7%), bolstered by strong gains across Emerging Markets and Asia and easing energy prices.

Emerging markets were led by Taiwan (Taiwan Stock Market Index +45.98%) and South Korea (Korea Composite Stock Price Index +67.89), where strong demand for advanced semiconductors, memory chips, and artificial intelligence infrastructure supported technology shares and exports. Taiwan's export growth accelerated alongside demand for AI-related hardware, while South Korea recorded strong semiconductor exports as investment in AI increased demand for memory chips. These trends helped lift the MSCI Emerging Markets and MSCI Asia Indices by 24.1% and 21.5%, respectively.

The MSCI EAFE Index gained 11.1% during the quarter, reflecting positive returns across developed markets outside North America. Japan and Europe's largest equity markets also advanced, although returns trailed the stronger technology-driven gains across emerging Asia.

As oil prices retreated from earlier-quarter highs, lower energy costs provided relief to major importing economies, including Japan, South Korea, Taiwan, Germany, France, Italy, and Spain, by reducing transportation and production costs. Conversely, weaker crude prices created a more challenging environment for energy producers and several commodity-exporting markets, contributing to the MSCI Latin America Index's decline of 3.4%. The MSCI Europe Index also gained 12.2%, participating in the broader advance across developed international equities.

Major commodities declined as energy prices eased and domestic rate outlooks rose. Demand for traditional safe-haven assets weakened in favor of risk-on sentiment.

Energy prices posted some of the largest declines. WTI Crude Oil Futures fell 31.4% as fears of a prolonged Middle East supply shock eased towards the end of the quarter. Precious metals moved lower during the quarter, with Gold and Silver declining 14.1% and 22.0% against the dollar, respectively. After a strong 2025, this reflected a shift toward riskier assets, higher rate expectations, and precious metal price stabilization.

Crypto faced another challenging quarter, remaining significantly more volatile than traditional asset classes. Bitcoin fell 14.0% during the quarter and is now down nearly 33.1% year-to-date, while Ethereum and XRP declined 25.3% and 22.6%, respectively. Higher interest rates and tighter financial conditions continued to reduce investor appetite for speculative assets. At the same time, regulatory developments remained an important focus for the market as Congress continued working toward greater clarity for the cryptocurrency industry.

The GENIUS Act established a federal framework for regulating payment stablecoins, while the CLARITY Act continued to move through Congress with the goal of creating a broader regulatory framework for digital assets by defining the responsibilities of the SEC and the CFTC. Although these developments were viewed as positive steps for the industry, uncertainty around when and how future regulations will be implemented kept many institutional investors cautious, limiting broader participation in the crypto market.

Looking ahead, regulation is expected to remain an important driver of the cryptocurrency market. Continued progress toward a clearer regulatory framework could improve investor confidence, encourage greater institutional participation, and support the long-term growth of the digital asset industry. However, the timing and final scope of future legislation remain uncertain, and investors are likely to continue monitor policy developments closely.

U.S. fixed income underperformed international in Q2 on a hedged and unhedged basis. This was due in part to the repricing of Fed policy expectations, primarily concentrated in the front-end of the curve, a trend that did not occur in major European economies like Germany, France, and Italy, despite the European Central Bank (ECB) hiking rates and the Fed holding rates constant.

Investment Grade (IG) and High Yield (HY) corporates outperformed on the quarter, with markets absorbing heightened issuance from AI infrastructure demands and risk-assets outperforming on the quarter. MBS returns were in line with the Agg as primary mortgage rates hovered around ~6.5% amidst ~4.9% 30Y yields.

Curve shape varied across regions, with U.S. yields exhibiting meaningful bear-flattening, Japanese yields bear-steepening, and major European curves bull-flattening modestly.

While both the Bank of Japan (BOJ) and ECB hiked rates in Q2, their curves responded quite differently. European curves bear-flattened in Q1 as investors anticipated imminent hikes, which, having been largely priced in, garnered a relatively muted reaction in Q2. Longer duration yields were well bid, particularly in the latter part of the quarter alongside easing energy prices. In the case of Japan, the BOJ’s history of easing to historically negative rates lends the central bank less long-term credibility in the success of tightening policy. Coupled with the country’s high dependence on energy imports, inflation concerns overshadowed the tightening in Q2.

In the case of the U.S., the passing of the torch from Jerome Powell to Kevin Warsh was in focus, as skeptics expressed concern that Warsh may be politically motivated to lower rates. As expressed in last quarter’s note, the trajectory of inflation and the labor market had left the Fed with little room to lower the target rate. In Q2, additional inflationary pressures stemming from elevated energy prices were added onto an already sticky Core Services rate, providing a more clearly hawkish backdrop for the Fed.

Pressure also occurred from the labor market as multiple Nonfarm Payrolls prints came in sharply higher than expected, adding to data suggesting resilience in Q1. Kevin Warsh’s debut meeting as chair of the Fed could be reasonably interpreted as hawkish, as he cited inflation as a key concern and emphasized the Fed’s continued commitment to 2% inflation. The combination of economic data and Kevin Warsh’s hawkish debut pushed front-end yields and rate policy expectations to reprice, with the Fed Funds Futures market moving from pricing in 0.29 25bp cuts in 2026 to one and a half 25bp hikes.