August 2026

Much has changed in the economy and markets since the beginning of this year.  The 2-year note was yielding 3.47% on December 31st, Fed Funds were 3.63% following the Fed rate cut at the December 2025 FOMC meeting, and the December 2026 Fed Funds future was implying that the overnight rate would end the year at 3.00%.

As we enter the fourth quarter the economic backdrop has improved markedly.  Employment, which saw average monthly gains of 38,000 May through July, surged in August.  The BLS reported that 162,000 new jobs were created in the month versus the expectation for 55,000.  That result exceeded even the most optimistic forecast of 125,000 put forth by a private economic forecasting firm.  In addition, the 23,000 lost jobs that were originally reported last month was revised to a gain of 21,000.  The unemployment rate remained unchanged at 4.1%, the lowest it’s been in nearly a year.

Economists caution that the August employment report can be tricky due to impact of local educational employment returning and the staggering of the first day of school for regions across the country.  Nevertheless, economic activity is showing signs of accelerating throughout the economy.  The just released Retail Sales tally for August showed a monthly gain of 1.2% over the July result and, more impressively, 5.3% when compared to August of last year.

As the employment picture has improved, inflation has reemerged as a concern.  The consumer price index has cooled markedly from the spike witnessed in 2021-2022.  However, since peaking at 9.1% the year-over-year registered 3.4% in August, rising from the 2.4% measured in January.  An unwelcome uptick.

What’s also changed since the first of the year?  Obviously, there is now a new Federal Reserve Chairman.  Now in his second round as a Board member, Kevin Warsh has historically erred on the side of being a hawkish, and since being appointed has hinted that there is more be done to battle inflation.  While he has been slow to act, the FOMC chose to finally raise the overnight rate at the September meeting, taking the overnight Fed funds rate corridor 25 basis points higher to 3.75%-4.00%.

We’d argue that the move was too little too late as witnessed by the price action in the bond market.  The two-year note is currently yielding 4.67%, 120 basis points higher than at the start of the year.  The 30-year bond has also risen in yield but about half of the move in the 2-year note, currently trading at a yield-to-maturity of 5.35%.

Looking to the Fed Fund futures market, the implication is that Fed Funds will be 75 basis points higher by this time next year.  Chairman Warsh’s comments at the post-FOMC press conference lead us to believe that he will seek to guide the committee to higher rates in incremental steps.  We expect that the committee will again raise the overnight rate at the December meeting then hold off on the next rate hike until March 2027.  Also, by year-end we hope to hear about the operating changes that Warsh plans to Federal Reserve.