August 31, 2026 

        Global bond markets have been battered this year by higher energy prices, inflation, competition from heavy AI-linked corporate borrowing and worries that governments will fail to rein in spending. In August, total U.S. government debt topped $40 trillion, including intragovernmental debt. Interest costs are now the third-largest part of the U.S. budget, after healthcare and Social Security. This, along with renewed tensions in the Middle East re-lifting energy prices and AI expansion accelerating prices of computers and other high-tech products, are seen as risks to returning inflation to the Fed’s 2.0% goal. Treasury Secretary Bessent’s announcement of plans to at least double the size of liquidity buyback operations for securities dated from the 10-year to the 30-year sector may also make the Fed’s task of bringing down inflation more difficult. His efforts to “buy down” the yield on longer-duration bonds sits in sharp contrast to Fed Chairman Kevin Warsh’s stated belief that the rise in long-term borrowing costs has served a valuable purpose in tightening financial conditions in an economy with inflation still elevated and sending key signals to the central bank, if not doing the central bank’s job.

     Economic growth in the U.S. continues but is starting to look more fragile. There is manufacturing strength paced by AI-related capital spending, defense needs, and inventory rebuilding. The larger service sector also continued to expand in July. On the other hand, labor market momentum has been uneven. Employment reported its second consecutive soft print. Non-farm payrolls declined by 23,000 in July, following a combined 103,000 downward revision to the May and June figures. The unemployment rate ticked down to 4.1% as labor force participation slid and wage growth slowed. The slowing wage growth combined with elevated costs of essentials and a historically low savings rate is proving to be a headwind to household consumption. July’s retail sales fell 0.6%, the largest decline since May of 2025. And consumers are becoming more pessimistic based on noted surveys, suggesting retrenchment may be ahead.

     While still above the Fed’s long-range target, inflation gauges over June and July suggest some moderation in price pressures. Since May, core CPI has trended lower from 4.2% to 3.4% in July. The relief that the Federal Reserve has been looking and hoping for, however, may not continue. Personal Consumption Expenditures (PCE) Deflators have proven to be stubborn. Both headlines and core (excluding food & energy) rose 0.2% in July, an increase from -0.1% and +0.1%, respectively, in June. An escalation of the Iran war poses a risk to the outlook for inflation by threatening to push oil and consumer prices higher. In addition to ongoing geopolitical tensions, there are also uncertainties over tariffs, shifting trade relationships and the potential for weather adversely affecting agriculture and food prices.

        The minutes of the July Federal Open Market Committee (FOMC) meeting reaffirmed the assumption that the Fed is prepared to raise rates if inflation is persistently elevated. Fed Chairman Warsh’s elimination of forward guidance has complicated the policy outlook, as have Treasury Secretary Bessent’s plan to suppress yields on longer duration Treasury maturities, taking away the market’s expectations function. At the Kansas City Fed’s annual symposium in Jackson Hole, Wyoming, Fed Chairman Keven Warsh, in the keynote address, hit back on Bessent’s plan by saying the Fed “needs clear market signals, as unfiltered as possible.” He also said that inflation is the more concerning part of the central bank’s dual mandate. Broad inflation measures have fallen significantly from their 2022 peak, but progress over the last two years has been modest. Warsh reiterated that the Fed must be confident that underlying inflation is moving toward its 2.0% goal, clearly and at sufficient speed, otherwise the Fed has work to do. The markets assessed his speech as hawkish, lowering the bar for raising policy rates. The financial markets have been questioning the credibility of the Fed as an inflation fighter, and the steep yield curve provides clear evidence of that. Following up this speech with a quarter point rate hike at the mid-September FOMC meeting might go a long way toward rebuilding the credibility of the Fed and its chairman, as well as demonstrating their independence.