Three Macro Factors Affecting Risk Appetite

Investors have spent much of the summer navigating a familiar tension: an economy that continues to show resilience even as concerns linger over inflation, fiscal deficits, and geopolitical risks. Yet beneath the daily headlines, several underlying forces are helping to keep financial markets on relatively stable footing.

Three developments stand out. First, continued demand for U.S. Treasury securities from Japan, the largest foreign holder of U.S. government debt, remains an important source of support for global capital markets. Second, financial conditions in the United States remain easier than in most major developed and emerging economies, providing a favorable backdrop for risk assets. Third, while inflation remains above the Federal Reserve's (Fed) target, price pressures have moderated since their spring peak, helping to reinforce expectations that longer-term inflation expectations will stay anchored.

Taken together, these trends suggest that investors are looking beyond near-term uncertainties and focusing on a global macro backdrop that, while far from risk-free, remains more constructive than many anticipated earlier this year. Understanding these dynamics helps explain why markets have continued to absorb economic and geopolitical shocks with relatively limited disruption.

Japan is the Largest Foreign Holder of U.S. Treasuries

Source: LPL Research, U.S. Treasury 08/18/26

First, U.S. Needs Japan to Keep Buying

Japan is the largest foreign holder of U.S. Treasuries, and the U.S. needs to keep Japan’s demand for our debt as robust as possible. Japan runs a large trade surplus with the United States and has accumulated significant foreign currency reserves, especially in U.S. dollars. Further, U.S. Treasuries are the world’s largest and most liquid government bond market, making them a natural place for Japan to invest those reserves while preserving capital. Investors need to be aware of any shifting trends within Japan but for now, Japan buys Treasuries because they are the safest place to invest its dollar reserves and the Treasury market is large enough to absorb Japan’s significant overseas investment flows.

Second, Financial Conditions Favor the U.S.

In this next chart, you see that the U.S. has the least financial stress among both developed and emerging markets.

Financial Conditions are Better than Average

Source: LPL Research, Office of Financial Research, 08/18/26

Values below zero imply financial markets are below average stress levels. While all three lines are below average stress, the U.S. is ranked with the lowest stress right now.

Is it a bit of complacency? That’s possible, but at this point, investors are looking past the near-term headwinds.

Third, Inflation Conditions Improved Since May

Although the Fed is still concerned with the pace of consumer inflation, we have seen some improvements.

The Worst Inflation Has Passed

Source: LPL Research, AAA, Bureau of Economic Analysis, Bureau of Labor Statistics, NY Fed 08/18/26

Conditions in February were quite promising as the trajectory implied that inflation was heading toward the 2% target to be reached by early next year if not sooner. But then came the Middle East conflict and a shock in oil prices. We hit the highest inflation metrics in May but since then, we’ve seen some improvement despite the on-again-off-again agreements.

Looking ahead, one of the most important things right now is keeping two- and five-year inflation expectations well anchored. If so, then we may have averted larger disruptions.

So What?

For investors, the macro factors suggest the foundations of the current expansion remain intact. Continued foreign demand for U.S. Treasury securities and a proactive Treasury Secretary (as witnessed Wednesday) help underpin funding markets, relatively easy financial conditions support economic activity, and recent progress on inflation reduces the likelihood of a more disruptive policy response from the Fed. While bouts of volatility should be expected given ongoing geopolitical and policy uncertainties, the backdrop argues for maintaining strategic exposure to equities while preserving diversification through high-quality fixed income. In other words, the macro environment does not appear to warrant a defensive posture, but it does reinforce the case for balance: participate in growth opportunities while recognizing that bond yields remain attractive and can provide valuable ballast if market conditions become less forgiving.