While the Fog of War Lifts, AI Risks Still Cloud the Horizon

This has helped ease concerns around the war’s impact on both inflation and global growth, which has been well received by markets; government bond yields (which move inversely to prices) initially moved lower as inflation concerns eased, equity markets strengthened, while sectors and regions most exposed to higher energy costs benefited from the improvement in sentiment.


Equity markets remain strong, but sensitive to changing expectations

While the US/Iran ceasefire helped markets to recover from a mild downturn in the early part of the month, June saw a small decline in US and Asian equity markets overall (largely tied to artificial intelligence (“AI”) themes), while Europe and the UK delivered modestly positive monthly performance, as the ceasefire news was seen as a stronger tailwind for these regions. While global performance was mixed over the month, we note this should be put in the context of an exceptionally strong quarter and year-to-date performance for global equity investors.

Over the second quarter of 2026 equity markets continued to deliver strong performance, although returns varied across different regions. The US, Emerging Markets and Asia Pacific regions performed best, helped by the continued success of companies benefiting from the growing demand for AI.

While overall market performance was materially positive in Q2, we note this has coincided with periods of increased volatility in individual stocks, sectors, and themes. Investor enthusiasm remained concentrated in AI-related companies, leading to stronger gains in those businesses while some other sectors lagged. This reflects a common feature of markets when a particular theme captures investors' attention.

When companies are growing very quickly – as we are seeing with many AI-related businesses – their share prices are often more volatile. This is because investors expect these companies to earn much more money in the future than they do today.

As a result, a large part of their value is based on what investors believe they will achieve over the years ahead. If expectations about the economy, interest rates or the company's future growth change, even slightly, their share prices can move quite sharply. By comparison, companies that are expected to grow at a steadier pace tend to be less affected by changes in these expectations, so their share prices are often less volatile.

In recent weeks, some of these technology shares have weakened as investors have been reassessing companies’ valuations and how quickly they will benefit from AI-related investment. Despite this reassessment businesses are still expected to deliver strong profits, and investment in the technology behind AI remains substantial. While periods of volatility are likely to persist, we continue to view developments in artificial intelligence as a potentially significant long-term driver of productivity and economic growth.

History suggests that major technological transitions are rarely a straight line for markets, but investors who remain focused on longer-term prospects rather than short-term share price movements have often been best placed to benefit from the opportunities they create.


Interest rate policy is beginning to shift

Over the first half of 2026, following the US-Iran conflict and the associated impact on commodity prices, markets have shifted from expecting interest rate cuts in 2026 to pricing a greater risk of higher interest rates across several major regions.

In the US, June marked the first Federal Open Market Committee meeting chaired by Kevin Warsh, the new Federal Reserve Chair. Prior to Warsh’s formal appointment, markets had generally expected the Fed to lower interest rates through 2026, under his leadership. While the US Federal Reserve left interest rates unchanged during their June meeting, its comments suggested that interest rates may stay higher for longer than investors had previously expected, with policymakers increasingly focused on inflation risks. The Fed’s June projections also showed a greater split among policymakers, with several officials pencilling in interest rate increases before year-end. This has contributed to rising market expectations for US interest rates over the next 12 months, despite the interim US-Iran agreement and sharp fall in oil prices.

Elsewhere, central banks continued to respond to differing economic conditions across regions:

• The Bank of England left rates unchanged, holding Bank Rate at 3.75% by a 7-2 vote, with two members voting to raise rates to 4%. The Bank continues to balance weak growth against the risk that higher energy prices could feed into broader inflation expectations and wage-setting.
• There were also significant political developments during the month, with Prime Minister Starmer announcing his resignation, and newly elected Makerfield MP Andy Burnham, emerging as the favourite to replace him. Thus far, financial markets have reacted relatively calmly, aided by statements from Burnham committing to existing fiscal rules, helping (along with the ceasefire news) UK bonds to deliver positive performance for the month. While there may be a period of heightened volatility given gilt and sterling markets sensitivity to fiscal credibility, we ultimately don’t expect political and policy developments to exert sustained negative impact on UK bonds.
• The European Central Bank raised key interest rates during June by 25 basis points citing continued inflation pressures. At the same time, policymakers acknowledged a relatively modest growth outlook, highlighting the balancing act facing European policymakers.
• In Japan, the Bank of Japan raised interest rates to their highest level in 30 years, continuing its gradual move away from the ultra-low borrowing costs that have shaped the country's economy for decades.
  
  
  What does all this mean for investors?

While a lasting US-Iran agreement has yet to be reached, June marked an important step towards reducing one of the key uncertainties facing markets this year. The resulting decline in oil prices has eased concerns around both inflation and global growth and improved the near-term outlook.

At the same time, investors continue to adjust to a world where interest rates may remain higher for longer, while some of the companies that have driven market returns in recent years remain particularly sensitive to changes in growth and interest-rate expectations. This could continue to contribute to periods of market volatility.

For long-term investors, the message remains unchanged. Periods of market volatility are inevitable, but successful investing is rarely driven by reacting to short-term headlines. Maintaining a diversified portfolio and staying focused on long-term fundamentals remains the most effective way to navigate uncertain market environments.