by Rebecca Anderson

Sage Insights: Higher Rates Meet Broadening Productivity

August delivered generally positive market returns, but the experience was far from uniform. Interest rates remained elevated as investors weighed persistent inflation, a more hawkish Federal Reserve stance, continued government fiscal imbalances globally, and increased corporate bond issuance.

At the same time, second-quarter earnings provided growing evidence that artificial intelligence is beginning to improve productivity and profitability beyond the technology companies that have dominated the AI story.

Together, these developments point to an environment in which higher financing costs can coexist with improving corporate productivity, while market leadership remains uneven.

Sage’s strategy, in this climate, is to provide flexibility within fixed income to navigate a world of higher long-term rates, and broad equity diversification to participate as AI-driven productivity gains spread across the economy.

Monthly Market Recap

Fixed Income Markets

Bond performance was shaped by rising yields tied to hawkish Fed commentary, while resilient global economic growth and tighter credit spreads provided support.

  • U.S. taxable bonds gained 0.4%, as tightening of credit spreads helped offset a rise in yields driven by sticky inflation and a more hawkish Fed stance following Chair Warsh’s Jackson Hole remarks.
  • Tax-exempt bonds fell 0.2%, as heavy seasonal summer issuance combined with rising longer-term interest rates weighed on the municipal space.
  • High-yield bonds rose 1.0%, outperforming investment-grade debt as elevated coupon income and resilient consumer spending data more than offset broader rate volatility.
  • International bonds gained 0.5%, as a softer U.S. dollar boosted unhedged international bond returns, helping offset the same upward pressure on global yields that weighed on domestic fixed income.

Equity Markets

August’s equity gains were driven by AI strength and a weaker dollar that lifted U.S. large-cap, international, and emerging market stocks, while rising Treasury yields and hawkish Fed commentary from new Chair Kevin Warsh weighed on smaller, more rate-sensitive U.S. companies.

  • U.S. large-cap equities gained 2.7%, as cooling inflation data early in the month and continued momentum in AI-related technology names pushed the S&P 500 to fresh record highs, even as investors weighed a more hawkish tone from new Fed Chair Kevin Warsh and renewed U.S.-Iran tensions late in the month.
  • U.S. mid-cap equities inched up just 0.2%, while small-cap equities slipped 0.6%, as Chair Warsh’s commentary around getting inflation to 2.0% and a jump in Treasury yields pressured smaller businesses more reliant on floating-rate debt, which increases borrowing costs.
  • International equities rose 2.6%, supported by a softer U.S. dollar and the strongest earnings quarter in 4 years, which helped offset caution around Middle East-related geopolitical risk.
  • Emerging market equities climbed 3.4%, led by continued strength in semiconductor and AI-hardware holdings such as TSMC, Samsung Electronics, and SK Hynix, as a weaker dollar and steady capital inflows continued to support the asset class’s benchmark-heavy tech exposure.

Long-Term Rates Remain Elevated

Long-term interest rates remain elevated in the United States and across many developed markets. While Federal Reserve policy is an important influence with the next meeting in mid-September, it is only one of several forces affecting longer-term yields, along with growth and inflation, government borrowing, and the term premium.

  • Growth and Inflation. The macro picture remains on a good path as consumer spending and AI-driven business investment have stayed relatively strong. Inflation in the U.S. remains above the Federal Reserve’s 2.0% objective, limiting policymakers’ flexibility to decrease interest rates. The latest inflation reading was 3.7%[1], driven by elevated energy prices and goods. At its July meeting, the Federal Reserve held its target rate steady at 3.5% to 3.8%, but three voting members favored an increase, underscoring continued concern about persistent inflation.
  • Government borrowing. Persistent federal deficits require substantial Treasury issuance, while corporations are also borrowing to fund investment as part of the artificial intelligence buildout. Collectively, greater bond supply does not automatically push yields higher, but increased issuance may require more attractive yields to meet investor demand.
  • Term premium. Long-term yields also include a term premium, the additional compensation investors require for committing capital when the future path of inflation, growth, and policy is uncertain.

Taken together, these factors may keep long-term interest rates elevated, even if the Federal Reserve adjusts short-term policy rates.

The opposite outcome is also possible. If economic growth weakens materially, longer-term yields could decline more quickly than shorter-term yields, which is one reason intermediate-duration, high-quality bonds continue to play an important role in diversified portfolios.

Sage believes the most prudent approach is to prepare portfolios for a range of economic and market outcomes rather than relying on a single interest-rate forecast. We do this by selectively using shorter-duration and flexible strategies to generate income while limiting unnecessary sensitivity to rising rates, complemented by intermediate-duration, which can provide diversification if growth slows and yields decline.

We believe this positioning can perform favorably across several rate environments.

AI Productivity Is Moving Beyond Technology

A notable takeaway from Q2 earnings season is that artificial intelligence is beginning to affect day-to-day business operations. Investors have wanted clearer evidence that AI spending can translate into durable earnings and cash flow, and second-quarter results offered some early support.

Some of the clearest examples are emerging outside the technology sector:

  • Waste Management has reported operating benefits from technology that improves routing and service efficiency. The company’s AI-focused “Smart Truck” platform is forecast to generate $300 million of annual EBITDA.
  • C.H. Robinson has attributed significant productivity gains to more than a 60% increase in shipments per person per day since 2022, partly to AI and automation.
  • Willis Towers Watson expects process automation and related technology initiatives to produce meaningful savings of $400 million annually through the “AI Acceleration Plan.”

The blended net profit margin for U.S. large-cap stocks in Q2 2026 is 17.0%. If that holds as the final reading, it would be the index’s highest quarterly net profit margin since 2009. AI is only one of several factors supporting profitability, but a growing number of companies are identifying it as a contributor to improved efficiency and margins.

These examples matter because they may point to a broader shift. AI is becoming a real-world business application story, not just a technology platform story. Bloomberg reported that, among 25 large U.S. companies that specifically quantified the impact, AI programs were associated with roughly 1.8 percentage points of margin improvement. Although the sample is limited, durable gains across a broader range of companies could strengthen the case that continued investment in AI infrastructure is sustainable, which remains a key question for markets.

The first phase of the AI investment cycle disproportionately benefited the companies supplying semiconductors, computing capacity, data centers, and related infrastructure. If the technology increasingly improves productivity across the wider economy, potential beneficiaries could expand to companies that use AI effectively, regardless of whether they are generally considered “AI companies.”

Broader AI adoption could support margins and improve productivity, reducing inflationary pressure as the economy meets rising demand instead of demand simply bidding up prices. However, implementation is costly, execution risk is real, and not every investment will generate an attractive return.

That is why broader equity diversification remains important. The rationale does not depend on predicting when market leadership may widen. Instead, it reflects the potential for productivity gains, earnings growth, and attractive valuations to emerge across industries, company sizes, and regions over time.

Closing Thoughts

This past month provided favorable market returns and reinforced two important ideas for portfolio positioning.

First, long-term interest rates may remain elevated even if short-term policy rates eventually decline. Persistent inflation and continued government and corporate borrowing can all keep pressure on longer-term yields upward.

Second, the AI story is starting to broaden as second-quarter earnings showed encouraging signs that productivity gains are beginning to appear in other areas of the economy as well.

Taken together, these trends reinforce the value of balance: flexibility within fixed income to navigate a world of higher long-term rates, and broad equity diversification to participate as AI-driven productivity gains spread across the economy.

In our view, the objective is not to predict exactly where rates go next or which companies ultimately capture the greatest benefits of artificial intelligence. It is to build portfolios that do not depend on a single answer and can stay resilient while remaining positioned for opportunity.

 

 

Footnotes

[1] Personal consumption expenditures (PCE) measures spending of goods and services by and on behalf of the personal sector, which includes both households and nonprofit institutions serving households.

 

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