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As Q3 comes to a close, BMO is pleased to share the latest edition of our Software Market Update. In addition to our perspectives on the current macro environment and capital markets activity, this edition examines how AI is reshaping software pricing models, cost structures, and margin profiles.
The era of low interest rates officially ended in Q3 with the Federal Reserve unanimously raising the federal funds target range by 25 basis points to 3.75% to 4.00%, citing elevated inflationary pressure primarily from rising gasoline and diesel prices. Yields have also risen swiftly across the curve, with the 5-year Treasury reaching above 5% and 30-year hitting the highest level since 2004. The shift in Federal Reserve rate hike expectations continues to play a role in rising yields, with Fed funds futures currently pricing in almost four more quarter-point rate hikes by the end of 2027.
The labor market remained stable, with continued employment growth and limited evidence of widespread AI-related displacement to date. U.S. nonfarm payrolls increased by 162,000 in August, the unemployment rate held at 4.1%, and labor force participation increased to 61.6%. Longer term, productivity gains from AI and demographic trends may moderate employment growth, but the more immediate impact is likely to be a change in workflows and job composition rather than broad workforce displacement.
Software equities advanced during the quarter, as strong earnings and sustained enterprise technology spending eased concerns regarding an AI-driven slowdown in demand. Each of the subsectors we track exceeded consensus revenue and EPS expectations; however, share-price reactions remained selective and valuation dispersion remains pronounced. Premium multiples are increasingly concentrated among companies demonstrating durable growth, strong free cash flow, and tangible AI monetization. Cybersecurity continued to outperform, while performance across application and vertical software was more differentiated. Investors are evaluating data advantages, how embedded the software is in workflows, and the investment required to compete in an AI-enabled market.
Software M&A activity has been elevated, supported in part by a small number of transformative transactions. North American software M&A generated approximately $727 billion of announced value year to date across 203 transactions, including approximately $250 billion and $60 billion attributed to the xAI and Cursor transactions, respectively. Excluding these two mega-deals, announced value totaled approximately $417 billion, exceeding recent historical averages and indicating an improving underlying transaction backdrop. Venture investment has followed a similar pattern, with AI accounting for approximately 86% of U.S. venture capital investment value in the first half of 2026.
Our analysis of AI pricing finds that subscription and platform fees remain the recurring foundation for most software companies. However, vendors are increasingly layering in consumption-based components to align monetization more closely with customer usage and recover variable inference costs. While this approach does not fully offset margin pressure, declining model costs, improved cost per query, and more disciplined packaging are creating a credible path toward margin expansion as AI adoption scales.
BMO remains highly engaged with clients across M&A, financing, and strategic advisory, helping companies and investors navigate evolving macroeconomic conditions, valuation dispersion, and structural change across the software ecosystem.
We hope you find the update helpful and welcome the opportunity to discuss any of these themes in greater detail.
To receive the full report, please contact our team.