Inflation

The benchmark 10-year Treasury yield fell below 4% on Friday as investors reacted to a stronger-than-expected January wholesale inflation report. Core wholesale prices stripped of food and energy rose 0.8% month-on-month in January — nearly triple the 0.3% consensus — confirming that tariff-related cost pressures are embedding in the producer pipeline. Headline PPI rose 0.5%, also well above the 0.3% forecast. The bond market's paradoxical response — yields falling despite a hot inflation print — reflects a growing market conviction that the growth deterioration and AI-sector disruption fears are the more immediate macroeconomic threat, even as price pressures clearly reassert themselves. Core PCE, which the Fed targets at 2%, stood at 3.0% as of the most recent reading, with limited progress from the mid-2025 levels. The Fed's path to 2% has stalled.

What makes the inflation picture distinctly challenging is the compositional shift in price pressures. Goods disinflation — the primary driver of the 2024 disinflation narrative — is now reversing. The ISM Manufacturing Prices Paid Index jumped 11.5 percentage points to 70.5% in February, its highest reading since June 2022, driven by tariff-induced input cost acceleration. Services inflation remains stubbornly elevated, particularly in shelter (OER), healthcare, and select consumer services. Average hourly earnings rose 0.4% month-on-month in January — above the 0.3% consensus — keeping wage growth uncomfortably above levels consistent with 2% PCE. The January 2025 CPI base effects that temporarily suppressed year-over-year readings are now exhausted, and with oil prices surging 12–14% on the Iran strikes, the second-quarter inflation pulse is now tracking materially above the Fed's projections.

Risk and Positioning

The risk regime entering this week is best characterized as deeply risk-off with asymmetric geopolitical overlay. On Friday alone, the Nasdaq lost 0.92% while financials were battered by exposure fears tied to the collapse of UK mortgage provider Market Financial Solutions — Barclays fell 4%, Jefferies nearly 8%, Wells Fargo dropped 5%, and Apollo shed 7%. UBS's head of global equity strategy downgraded American equities to "benchmark," citing mounting risks from a weakening dollar, stretched valuations, and policy turbulence, while the MSCI World ex-US index has gained approximately 8% in 2026 compared to the essentially flat performance of the S&P 500. The VIX closed Friday at 19.86, up 6.60% on the session, but this reading is profoundly pre-event. Monday morning will see VIX price discovery into the mid-to-upper 20s at minimum, potentially higher if oil moves provoke inflation re-pricing across the options surface.

Equity positioning entering the Iran escalation was already fragile. The S&P 500 and Nasdaq finished February in the red, with the Nasdaq bearing the brunt of AI disruption fears triggered in part by Duolingo's 14% collapse after guidance disappointments. Block announced layoffs of more than 4,000 employees — nearly half its workforce — amplifying fears that AI displacement of knowledge-worker roles is accelerating beyond expectations. This narrative strikes at the heart of the tech sector's earnings growth assumptions, which underpin the bulk of the S&P 500's valuation premium. Meanwhile, the 10-year Treasury yield fell below 4% for the first time in four months, ending February roughly 25 basis points lower — its strongest monthly performance in a year, consistent with a bond market increasingly pricing recession risk over reflation.

Defensive positioning is warranted but complicated. Gold was already bid on safe-haven flows, and the Iran escalation will accelerate that demand. Treasury demand is robust — the 2-year yield fell to 3.38%, its lowest since August 2022, with the 2s10s spread at +59 basis points and steepening, a classic late-cycle signal. Credit spreads had remained relatively contained through February, but the combination of financial sector stress (MFS mortgage lender collapse) and geopolitical shock creates a credible path to meaningfully wider high-yield spreads this week. The critical anomaly to monitor is the dollar: despite a geopolitical shock that historically drives dollar strength, the DXY fell 0.19% Friday and is structurally weak at 97.61, down from 107+ a year ago — a "Sell America" dynamic that reflects eroding confidence in U.S. fiscal and policy credibility.

Sector and Cross-Asset Analysis

Friday's sector performance illustrated the competing pressures that will define the market's character in 2026. Energy should have outperformed on the PPI surprise and geopolitical tension; instead, financials led the carnage on MFS-linked credit exposure, while energy names saw modest support. Technology and communication services face a dual headwind: rising input costs (particularly energy for data centers) and a structural AI disruption narrative that is beginning to hit revenue guidance rather than remain speculative. Duolingo's collapse was instructive — this was a company that previously benefited from AI tailwinds, now reporting that AI tools are compressing its user growth economics. The market is starting to price AI as a deflationary force for software subscription businesses, even as it remains a capital expenditure tailwind for semiconductor and infrastructure plays.

The cross-asset picture is dominated by three divergences that demand attention. First, international markets are outperforming the U.S. materially — the MSCI World ex-US index up roughly 8% year-to-date against an essentially flat S&P 500, driven by European fiscal expansion, cheaper valuations, and dollar weakness. German DAX has been a particular beneficiary. Second, the bond-equity correlation has returned to the old safe-haven regime — yields falling as equities sell off — which means Treasuries are once again functioning as portfolio ballast. Third, and most critically for this week, Brent crude surged 14% and WTI 12% after markets reopened on Sunday evening following the Iran strikes, a supply shock that ripples across every asset class: higher energy costs, renewed inflation expectations, weaker consumer purchasing power, and potential drag on aviation, logistics, and petrochemical margins.

Equal-weight SPX was underperforming its cap-weighted counterpart through February, a concentration signal that indicates the index's modest decline masks more serious damage in the broader market. Small-cap Russell 2000 fell 1.68% on Friday, while large-cap indices posted more modest losses, reinforcing the narrow-leadership dynamic. Consumer discretionary and financials are the sectors most exposed to both the weakening growth narrative and the credit stress emerging from the UK mortgage market. Energy will be the pivotal sector this week — it enters Monday with fundamental tailwinds but positioned against a broader risk-off backdrop that often causes commodity sectors to initially correct before fundamentals reassert.

Economic Data & Events

Today's Calendar

• 8:00AM MT - ISM Manufacturing PMI (February) - High Impact
• Forecast: 51.8 | Previous: 52.6