August Month-End Market Update

Warsh Signals Hawkish Bias

At the Jackson Hole Symposium, Fed Chair Kevin Warsh reiterated themes from his recent FOMC press conferences, emphasizing that inflation remains the Fed’s primary focus. He also used the speech to clarify several issues raised at the July FOMC meeting that had generated questions among market participants, addressing them directly and firmly. 

Warsh stated that financial conditions are not restrictive, the labor market is consistent with full employment, and the Fed’s “predominant focus right now should be on prices”—a message that the market interpreted as hawkish. At the same time, he emphasized the importance of waiting for evidence that inflation is moving sustainably toward the Fed’s objective, saying, “We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do.” This suggests the Fed remains data dependent: a stronger-than-expected inflation reading could increase the likelihood of a rate hike, while in-line or softer data could support keeping rates unchanged.  

Warsh also clarified two issues raised at the July FOMC meeting: 

• Inflation Target: Regarding the potential use of alternative inflation measures, Warsh reaffirmed that the Fed’s 2% inflation target is based on the Personal Consumption Expenditures (PCE) price index, stating: “There should be no misunderstanding: The Fed’s price-stability objective of 2%, as measured by the personal consumption expenditures (PCE) price index, is a firm, fixed target.” 

• Monetary Policy Tools: On the potential use of the Fed’s balance sheet and other unconventional tools, Warsh emphasized that short-term interest rates remain the primary policy tool for achieving the Fed’s dual mandate. He added that unconventional policies should generally be reserved for genuine crises and “used sparingly, if at all.” 

Market Reaction 

Markets responded with a clear hawkish tilt. The 2-year Treasury yield rose 11 basis points (see chart below), while fed funds futures moved from pricing roughly a 35% probability of a September rate hike to above 50%. As of August 31^st, futures were pricing in more than a 60% probability of a hike at the September FOMC meeting (see chart below). 

September FOMC: Will the Fed Wait for PCE? 

One important consideration heading into the September meeting is an upcoming BEA revision to the PCE index, with revised data scheduled for release on September 30^th, 14 days after the FOMC meeting. Unless the CPI report released earlier in September shows a meaningful acceleration in inflation, the divided FOMC may ultimately choose to wait for the revised PCE data before making its next move. In fact, in his press conference, Warsh said, “a good majority of my colleagues and I thought the wiser course was to await new information in the intermeeting period.” Some estimates suggest the revisions could lower the year-over-year Core PCE reading by approximately 30 basis points, which could materially influence the policy outlook. 

Surprise Treasury Buyback Announcement

On August 19^th, the U.S. Treasury announced it would double the size of its longer-dated Treasury buybacks, increasing the minimum operation size from $2 billion to at least $4 billion beginning September 9^th. The Treasury said the move is intended to provide greater liquidity support to the long end of the market. 

The announcement comes as the rise in long-term Treasury yields this year has attracted increased attention from the Treasury Department, despite no evidence of broader liquidity issues or failed Treasury auctions. Yields have risen for a variety of reasons, including the large U.S. fiscal deficit, increased AI-related corporate bond issuance, stronger growth expectations, and elevated inflation concerns stemming from the conflict with Iran. The rise in yields has also been a global phenomenon, with government bond yields moving higher in Japan, Germany, France, Italy, and the U.K., suggesting this is not solely a U.S. issue. 

Importantly, while the 30-year Treasury yield reached a post 2007 high of 5.31% on August 17^th, that comparison needs to be put into context, as yields were at historically low levels during much of the period following the Global Financial Crisis. Despite the recent increase, the 30-year yield remains below its long-term historical average dating back to 1980 (see charts below). 

The buybacks are small relative to the roughly $40 trillion Treasury market and have had a limited impact so far, with the 30-year yield declining only 3 basis points since the announcement. This suggests that more meaningful fiscal measures to address the underlying deficit and supply concerns may be needed to drive a material decline in long-term yields. 

The positive takeaway is that the move signals the Treasury Department is willing to take steps to support liquidity and limit upward pressure on longer-term borrowing costs. However, with government borrowing needs remaining elevated and the midterm elections approaching, keeping Treasury yields and broader borrowing costs contained will remain an important consideration for policymakers. 

Yields Reverse Higher as Risk Assets Rally

Market headlines in August were dominated by the rise in U.S. and global government bond yields. As noted above, the U.S. 30-year Treasury yield reached 5.31%, while Germany’s 30-year yield rose to 3.81%, its highest level since 2011. Japan’s 30-year yield reached 4.14%, the highest since 1999. However, yields reversed course later in the month, leaving the U.S. Treasury curve largely unchanged by month-end (see chart below). 

Risk assets performed well, with both investment-grade and high-yield corporate bond spreads tightening. All three major equity indexes reached record highs during the month, led by the Nasdaq (+3.99%), followed by the S&P 500 (+2.72%) and Dow Jones (+1.47%). 

The corporate bond market also remained exceptionally active. August set an all-time monthly record for investment-grade issuance at $175 billion, surpassing the previous August record of $136 billion set in 2020. This marked the third consecutive monthly issuance record, with September issuance expected to keep up the strong pace, as estimates already exceed $200 billion.