Economy, Stocks and Bonds
August 2026
The most recent Fed meeting did little to assuage concerns about inflation, or that the Fed’s new
stance on limiting “forward guidance,” will be good for the economy and markets. In general, we
disagree with Warsh’s assertion that by giving the market less input from the Fed, the markets will
be more informative as to the economy. Instead, we see greater uncertainty in markets leading to
higher volatility.
The latest readings for CPI were widely touted as showing “declining” inflation, which is
misleading. Lower energy prices, brought about by the “memorandum of understanding” were
largely driving the 0.4% month over month decline in overall prices. When factored out, the index
remained flat at a 0% change. With hostilities having renewed for several weeks, we are expecting
to see inflationary pressure reassert itself in the August report.
The month opened strongly for stocks, with the S&P 500 trading back near all-time highs, and this
is despite technology stocks (chipmakers in particular) being well off theirs. They say the market
climbs a wall of worry, and there is plenty to worry about. With that said, we do see elevated odds
of a volatile fall based on the high likelihood of continued combat in the Persian Gulf, structurally
higher energy prices and interest rates, and a consumer that is showing signs of becoming
increasingly stretched.
Treasury bond yields have risen by nearly a full percentage point since the conflict began in the
Persian Gulf. At the same time, high-quality corporate bonds have risen, but not by quite as much.
The implication is that default risk premia are decreasing, which doesn’t make sense in light of the
higher cost, inflationary environment. The intuition suggests that higher interest rates in general,
along with trade frictions, are likely to increase pressures on margins and thus earnings, scenarios
where the default risk premium should be rising instead of contracting. Currently, 5-year
investment grade corporate bonds are yielding 4.92% and 10-year paper is yielding 5.45%. It is
important to be mindful that the higher rates are likely to persist for the foreseeable future, along
with remaining volatility.
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