Markets Brief: Will the Fed Really Raise Rates in 2026?

Powered by strong first-quarter earnings, stocks have withstood rising bond yields and a lack of progress toward concluding the Iran war. In this week’s Markets Brief, we look at the odds of a Federal Reserve interest rate increase this year and the drivers of first-quarter earnings strength. We also look back at a headline-grabbing activist investor battle at ExxonMobil.

Will the Warsh Era Begin with Higher Rates on the Way?

On Friday, Kevin Warsh was sworn in as Fed chair, replacing Jerome Powell. In the bond market, traders are betting that the first move under Warsh’s leadership will be to raise interest rates, rather than lower them as President Donald Trump has demanded. According to the CME FedWatch Tool, there’s a 70% chance of the Fed raising the federal-funds rate by the end of the year. The heaviest odds (more than 40%) are on the Fed doing one quarter-point rate hike from the current target of 3.50%-3.75%. They see a 22% chance of two hikes.

John Briggs, head of US rates strategy at Natixis, is skeptical of that particular outcome. “If the Fed is going to raise rates because of inflation worries, it’s not going to do it once. It’s going to do it two or three times,” he says. Instead, he sees the current moves in the bond market as “getting to the idea of a rate hike cycle, but I don’t think we are all the way there yet … I don’t think the markets are fully convinced they’re going to raise rates.”

In the background, Briggs says investors are wary of making the same mistake they did in 2022, when the bond market (and central bankers) saw the jump in oil prices after Russia invaded Ukraine as transitory. For Briggs, given the current economic outlook, his base case is that the Fed keeps rates steady. Given a stable employment market, “I think they end up staying on hold for a long time.”

Inside Q1’s Blowout Earnings Season

Stocks may be facing growing headwinds from rate hike expectations and higher bond yields, but they’re enjoying a significant tailwind in the form of strong earnings growth. For the first quarter, companies in the S&P 500 are on track to post earnings growth of 28.4%, according to FactSet. That would be the fastest pace since the fourth quarter of 2021. The picture looks much the same for the Morningstar US Market Index, where the blended growth rate is running north of 25%—also the strongest reading since 2021.

“The earnings picture has been blockbuster,” says Eric Freedman, chief investment officer at Northern Trust Wealth Management. Freedman says several themes underlie the robust earnings performance. One is a force that’s often in the headlines: artificial intelligence. “From the tech standpoint … you have cloud computing, data warehousing, communications, peripherals where the demand is exceeding supply, along with the arms race of anthropic versus OpenAI versus Gemini,” he explains. “We expect that to continue ... We’re still in the build mode for AI.”

Second has been the strength of the consumer, but here, Freedman is a touch cautious. “This is probably a time when consumer spending starts to be tested a little bit,” he says. “There are still very healthy credit constructs, but at the margin, they are getting a little bit weaker.”

Freedman notes that the only broad weak point in first-quarter earnings came from healthcare. With a 3.2% decline, it was the sole sector in negative territory, according to FactSet. “But that has such secular tailwinds behind it, given an aging population and a lot of labor growth inside,” he says. “So even areas that have shown some pockets of weakness don’t give us long-term pause.” Looking ahead, any spending slowdown in tech and retrenchment among consumers “is probably a 2027 story into 2028, not a 2026 one.” Healthcare is the only sector to deliver negative earnings growth thus far, despite being the stalwart industry employer (more on that below).

Ironically, despite this negative earnings picture, markets expected an even worse quarter. Recognizing how vast and diverse the healthcare sector is, we continue to see better opportunities within private markets than in public markets.

A Pyrrhic Victory at ExxonMobil?

Just five years ago, attention was focused on thwarting climate change, and oil stocks had lagged for years. Against this backdrop, an upstart investor named Engine No. 1 made headlines by ousting three directors on ExxonMobil’s XOM board.

The Engine No. 1 slate won the support of the Big Three asset managers—BlackRock, Vanguard, and State Street—at a time when sustainable investing was also riding high. Reflecting on the proxy battle, Engine No. 1 said that before the campaign, Exxon had “no credible strategy to create value given the increasingly uncertain demand outlook in a decarbonizing world.” Its new directors had experience in lower-carbon energy. It said it also forced Exxon to exercise greater capital discipline, “reduce its emissions footprint, and [begin] to lay the foundations for a viable low-carbon business strategy.”

What a difference five years makes. Thanks to a series of oil supply shocks, including the Ukraine and Iran wars, Exxon stock has more than tripled, versus a roughly 84% rise for the US Market Index. This year, Exxon is up more than 30%. In the meantime, global emissions are rising, and sustainable funds are experiencing redemptions.

In hindsight, the Exxon board battle helped open the door for anti-ESG sentiment, according to Lindsey Stewart, a proxy voting analyst and director of institutional insights for Morningstar. “Those who look at it from a sustainable investing perspective are likely to be disappointed,” he says. “A lot of the ESG backlash … stems from 2021 with Engine No. 1.”

Exxon itself has pushed back against activist investors. In 2024, it sued two small activist investors who proposed that the firm do more to reduce its emissions. The suit was dismissed, but the group agreed not to pursue the proposal. Last year, it received permission from the SEC to allow retail shareholders to automatically vote in accordance with Exxon’s management. This year, it also moved to redomicile from New Jersey to Texas, where proxy advisors and activist investors see corporate laws as more management-friendly

Stewart observes that the planet keeps warming, and climate-related disasters are on the rise, suggesting that more climate-related action may lie ahead. “What unites institutional shareholders is a belief in shareholder rights and strong corporate governance,” he says. “If investors feel companies have pushed back too hard, we’ll start to see them coordinate to ensure their rights are respected and they have some say in how their capital is deployed.”