2026—The Year the Fed Pauses. Rates Range-Bound. Now What?

Macro

Our forecast for real gross domestic product (GDP) growth in 2026 is 2.5% (based on Franklin Templeton Institute’s Global Investment Management Survey), versus the Federal Reserve (Fed’s) forecast of 2.4% and the Wall Street consensus of around 2.3%. For the balance of this year, the main growth drivers we see are an extremely resilient consumer, fiscal stimulus resulting from the One Big Beautiful Bill Act and strong business investment fueled by the artificial intelligence (AI) buildout.
Revised data released a week ago showed the US economy grew at a 1.6% pace in the first quarter of 2026, led by business investment and consumer spending.
Kevin Warsh has now taken over as Fed Chair and faces a challenging backdrop. The Fed seems divided on the future direction of US monetary policy, as core inflation continues to run north of 3% versus the Fed’s stated target of 2%. The US-Iran war continues to weigh on the markets, but the US job market continues to hang in there, with unemployment still south of 4.5%.
Looking at Fed funds futures 15 months out, the market does not believe interest rates will be touched at all this year, and, as of now, a hike is fully priced in by the end of the first quarter of 2027. Prior to the US-Iran war, the market priced in two interest-rate cuts. Our base case remains that the Fed stays on hold in the near term. That can change, especially if the conflict escalates or drags on.
The labor market remains somewhat mixed. The most recent Challenger, Gray & Christmas’ report showed layoffs came in 16% higher compared to the prior month, and AI was cited as the top culprit. Weekly jobless claims for the week ending May 30 were reported at 225,000, slightly above expectations and above the prior week’s figure of 215,000. However, Friday’s nonfarm payroll print of 172,000 jobs added in May was more than twice what the market expected and the fourth time in the last five months above 100,000. Unemployment remained low at 4.3%, where it has been all year with one exception, February, when it came in a tick higher at 4.4%.
If unemployment remains low and inflation remains at 3% or so, it will be challenging for new Fed Chair Warsh to lobby the other voting members of the Fed that a rate cut in 2026 is warranted. Not much is expected at his first meeting in less than a couple weeks; however, all eyes will be on the dot plot (which Warsh has indicated he won’t personally participate in) as well as his first press conference, as the market looks for clues on the future direction of monetary policy.
As the conflict in the Middle East surpasses the three-month mark, oil prices remain volatile and elevated. Brent crude is trading around US$95, off its US$115 high but about 35% above its pre-war level. If prices move higher or stay even around this level throughout the rest of the year, the risk to global growth will become more pronounced.

Equities

We remain constructive on equities and believe that the market will continue to broaden, with small caps, value and emerging markets all having the opportunity to outperform. We maintain this call but also see opportunities in growth-style stocks. After the recent run, we do not think it is wise to chase highs but would use pullbacks to add to the broadening theme. We agree with the sentiment, “Buy the dips and sell the rips!”
Last week, the S&P 500 Index completed its ninth straight positive week, with a cumulative gain of about 19% over that stretch. However, this winning streak ended there. It is worth noting that over the past 50 years, that was only the fourth time that a positive streak extended beyond eight weeks, with the longest reaching 12 in 1985.
Almost every S&P 500 company has reported first-quarter earnings, and it was a strong quarter across most metrics. Per Bloomberg data, 84% of companies beat earnings estimates, with the average beat on earnings-per-share (EPS) at 16.3%. The S&P 500 EPS grew 27% year-on-year (y/y), led by the information technology sector, which grew EPS 49%. Roughly 81% of companies surpassed revenue estimates.
Earnings estimates for the rest of the year have also moved higher. The S&P 500 estimate for 2026 is 9% above where it stood on January 1. At the sector level, technology estimates are up 18%, materials 16% and energy 57%. Higher forward EPS explains much of the equity rally since March.
Emerging markets (EMs), as measured by the MSCI Emerging Markets Index, are up 25% this year, beating the S&P 500 by 14%, after doubling the S&P’s return in 2025. Strong earnings expectations for EM companies drive our constructive view on the asset class. So far this year, earnings expectations have increased, with the 2026 estimate now 26% above where it started the year, according to Bloomberg data.
A couple of weeks ago, SpaceX filed its S-1 for a public listing for this summer. OpenAI and Anthropic are also expected to go public this year. Investors will scrutinize the financials of these companies as they fail to gain greater insight into the path of AI spending and revenues. Per Pitchbook data, SpaceX last raised money in February at a post-money valuation of US$1.25 trillion, OpenAI in March at US$850 billion, and Anthropic on May 28 at US$975 billion. If the companies list near those last valuations, they rank #9, #14, and #12 in S&P 500 market capitalization, respectively. Their financial disclosures and IPO demand could become broader market catalysts in either direction.
Bottom line: We think the fundamental backdrop for equities remains strong, particularly for US equities across size and style, and for emerging markets. We believe it is prudent to reduce concentration, stay diversified, dollar-cost average, periodically rebalance and use consolidation to one’s advantage.

Fixed income

The biggest story in fixed income this year has been duration, not credit. That remained true in May as the 10-year US Treasury yield moved from 4.37% on May 1 to a high of 4.67% on May 19, before settling around 4.45% on June 4.
Our expectation that yields stay somewhat higher, with risk to the upside, supports a preference for relatively shorter duration exposure within portfolios. We would not be surprised to see yields remain volatile due to the US-Iran conflict and also new leadership at the helm of a somewhat divided Fed. Ultimately, we think the Fed remains on hold in 2026 and that the 10-year US Treasury should continue to trade in the range of 4.25% to 4.75%.
On the credit side, spreads tightened over the course of May. Investment-grade (IG) spreads now sit at 73 basis points (bps) as of June 4, essentially unchanged since the start of the month. High-yield (HY) spreads are at 263 bps, wider by six bps during the first week of June.
Strong fundamentals, a shorter duration stance and higher all-in yields make us comfortable owning HY despite tight spreads. As measured by the Bloomberg US Corporate High Yield Index, HY outperformed IG, as measured by the Bloomberg US Corporate Index, by more than 1% during the first five months of the year.
We remain bullish on municipal bonds and find taxable-equivalent yields to be attractive, along with robust fundamentals. Importantly, munis continue to offer potential diversification benefits to equities and relative to most other subsectors of fixed income. Read more about this asset class in “Municipal bonds are back.”

Sentiment

The percentage of bullish investors in the latest American Association of Individual Investors (AAII) survey ticked up slightly to 36.3%, up from 35.6% in the prior week. The percentage of bearish investors fell to 37% from 42%. There is no strong signal here in either direction, but a wall of worry seems to still be in place.
Bull markets peak on euphoria. Despite a strong price rally, sentiment indicates we are a long way from that.

From the US Market Desk will return with insights again next week.

Source of data (except where noted) is Bloomberg and Franklin Templeton Institute, as of June 5, 2026. Important data provider notices and terms 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.

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.

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

Hit rate: The percentage of positive positions or returns over a specific period.

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

Personal Consumption Expenditures (PCE) and core PCE: Measures the price changes in goods and services purchased by US households; core PCE excludes food and energy prices. Both are measures of inflation.

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. “Tight” 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 Aggregate Bond Index: The Barclays U.S. Aggregate Index is a broad-based bond index comprised of government, corporate, mortgage and asset-backed issues, rated investment grade or higher, and having at least one year to maturity.

Bloomberg US Corporate Index: Measures the investment grade, fixed-rate, taxable corporate bond market and includes USD-denominated securities publicly issued by US and non-US industrial, utility, and financial issuers.

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

MSCI Emerging Markets Index: A free float-adjusted, market capitalization-weighted index designed to measure the equity market performance of global emerging markets.

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

WHAT ARE THE RISKS?

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The allocation of assets among different strategies, asset classes and investments may not prove beneficial or produce desired results. Diversification does not guarantee a profit or protect against a loss.

Equity securities are subject to price fluctuation and possible loss of principal.

Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.

International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The investment style may become out of favor, which may have a negative impact on performance.

Large-capitalization companies may fall out of favor with investors based on market and economic conditions.

Small- and mid-cap stocks involve greater risks and volatility than large-cap stocks.

Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.

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IMPORTANT LEGAL INFORMATION

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2026—The Year the Fed Pauses. Rates Range-Bound. Now What?

Macro

Read more: Workplace Benefits: It’s Not a Communication Gap. It’s a Translation Opportunity.

Equities

Fixed income

Sentiment

Glossary of terms

Indexes

IMPORTANT LEGAL INFORMATION

2026—The Year the Fed Pauses. Rates Range-Bound. Now What?

Macro

Read more: Workplace Benefits: It’s Not a Communication Gap. It’s a Translation Opportunity.

Equities

Fixed income

Sentiment

Glossary of terms

Indexes

IMPORTANT LEGAL INFORMATION

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