The second quarter of 2026, and indeed the first half of the year, has been dominated by two major factors that have had repercussions, both positive and negative, throughout markets.
The ongoing conflict in Iran has driven an inflation shock and uncertainty over interest rates, while the artificial intelligence (AI) boom has led to a huge surge in demand for semiconductors (computer chips), most notably those in the DRAM (memory storage) space. As these factors have each had such an influence, it is worth examining how they have affected both bond and equity markets over the quarter.
The US launched its first attack on Iran at the end of February, but the situation still dominated headlines into the second quarter, and although there is currently a ceasefire, it is hard to say with any certainty that there has been a lasting resolution.
During the quarter there have been periods where the Straits of Hormuz reopened, albeit briefly, and other periods when tensions rose and the market fluctuated with this news flow.
The clearest reflection of sentiment over the war has been in the price of oil, as represented by Brent Crude. This peaked at $126 per barrel in April and stayed above $100 until June, when shipping through the strait resumed and tensions eased. Throughout the month, the price fell steadily, ending it trading at around $75 per barrel, not much above the $70 seen before the crisis.
A higher oil price has led to increased inflation across the globe, including those countries such as the US that are net exporters. Government bond yields reflect how markets believe central banks will react to inflation (amongst other drivers), and when indicators suggest it is going to move higher, bond yields move in the same direction in anticipation of higher interest rates to combat price increases.
This was seen most notably in the UK, where, pre-crisis, markets were predicting up to two interest rate cuts for the year. As the situation deteriorated, this shifted to pricing in the potential for up to three rate increases. While this always seemed extreme, and the view has moderated as oil has fallen, it remains the case that the consensus is that the best scenario is that the UK remains at 3.75% for the year.
The Federal Reserve in the US has followed a similar path. 10yr bond rates moved in tandem with the price of oil, again going from expecting rate cuts pre-war to rate rises in April and now back to the hope that they remain neutral.
The situation in the US is further complicated by a new Chair taking up position in May. Kevin Warsh was picked by President Trump – who has made no secret of the fact that he wants lower interest rates – and markets were uncertain as to the stance he would take.
It was something of a relief, therefore, when he stated that controlling inflation was his number one priority. Although this suggests that he would raise interest rates if inflation continued to be elevated, markets were buoyed by the fact that he acknowledged the potential for a problem with higher prices and that he wouldn’t just ignore this to do the President’s bidding.
The European Central Bank reacted more quickly and raised rates in June, despite the region having lower inflation than both the US and UK, and with many countries within the bloc having anaemic levels of economic growth, especially Germany. After the meeting, several of the rate makers were quoted as saying that they felt they would have to raise rates again, although this may change if the situation in Iran remains less volatile.
The quarter ended with the ceasefire holding, and it is widely assumed that it is in both parties' interest that hostilities don't recommence. Although the oil price has fallen, the knock-on effect of the blockade is likely to take some time to work its way through the economy; for example, gasoline prices in the US remain around 27% higher than they were before the conflict.
There is a backlog in the supply chain, and a significant amount of the infrastructure needed for extraction and transportation was destroyed. This is particularly the case with natural gas terminals that were struck early in the conflict and could take up to 2 years to return to being fully operational.
Equity markets continue to be buoyed by advancements in AI and technology, but in a change from the pattern seen over the last several years, this was reflected in the price of companies involved in the manufacture of semiconductors rather than the hyperscale firms building data centres. Some of the returns have been quite spectacular, particularly in those companies involved in the manufacture of memory chips. Micron, SK Hynix and Samsung are up 227%, 223% and 108% respectively year to date, and SanDisk an incredible 638% (all at time of writing).
Conversely, the returns of the earlier winners of the AI/Tech boom were moderate. In fact, three of the "Magnificent 7" mega-cap companies responsible for most market growth over the past five years are negative for the year to date, with only Alphabet (Google) showing a double-digit return (13%).
The reason for this rotation was renewed concern over the amount these companies are spending and questions about how they will monetise the technology to recoup the outlay. This came into sharp focus in June, when Apple announced a 20% price increase on some of its products, citing the surging cost of memory and storage chips required for data centre demand.
In addition to news such as this, several of these companies have issued bonds (debt) this year to help finance the build-out, raising questions over the sustainability of spending such huge amounts.
No one really doubts that AI will be transformative, but to justify the vast cost it will have to be fully adopted and used in most industries and economies, with a very rapid take-up. Therefore, news that is negative to this narrative – for example, Uber recently capped some internal AI tools because they were costing far more than expected – tends to weigh heavily on the sector.
The further noteworthy event in the technology sector was the Initial Public Offering (IPO) of SpaceX in June. It came to market at a price of $135 per share and quickly rose to around $225 before falling back to trade at around $157 at time of writing.
There are many questions over the structure of the company and the control that its owner, Elon Musk, has – for example, the only person that can fire him is himself – but the ambition of the project has certainly excited investors. Whether this is sufficient to justify such an extreme valuation of a company that is yet to make a profit will be seen over time.
Politics took centre stage in the UK, where Keir Starmer resigned as Prime Minister, paving the way for Andy Burnham to take control in September. Although UK Gilt yields have risen steadily over the year as Starmer's exit looked increasingly inevitable, since he announced his intention to step down, they have remained relatively stable. There are yet to be any real policy announcements from Burnham, and we don't know who his Chancellor will be. When these details are revealed, it will give markets the opportunity to decide whether they like the new regime or not.
One final point to make after what was an extremely "news-heavy" quarter is about the behaviour of the US dollar and how this contrasts with the months leading up to the Iran conflict.
For most of 2025, the dollar was weakening against most currencies, driven by a loss of faith in the US as a reliable trade partner in the wake of tariffs and the belief that interest rates in the US would be heading lower. There was broad talk of the end of US exceptionalism and, even from some quarters, a suggestion that the dollar could lose its status as the world's reserve currency, or at least that this position could be challenged. This led to what is referred to as the "debasement trade", where investors lose faith in the ability of central banks to protect the purchasing power of their currency, in this case dollars, and instead turn to real assets such as gold, silver and real estate as a hedge against inflation.
The Iran conflict changed this because, although the US has seen inflation like the rest of the world, the dollar regained some of its safe-haven status and attracted buyers, resulting in a roughly 2% increase in its value. Furthermore, the Federal Reserve looks likely to keep rates higher for longer, again making holding dollars more attractive.
On the other side of this trade, gold has fallen by around 11% since March, and other previous winners such as cryptocurrencies by considerably more.
Despite this, the overall background remains the same. The problems that caused dollar weakness pre-conflict haven't gone away; tariffs are still being used as a political weapon, and US debt to GDP is high with no sign of coming down. The question is whether a long-term resolution to the conflict will see the situation reverse and the dollar once more weaken.
Trevor Hubner
Lead Portfolio Manager | MKC Invest
