Friday, August 28, 2026

Macro Musings · Daily Briefing · Friday, August 28, 2026

The Fed is panicking about inflation so bond traders don't have to

US 2s/30s yield spread down 8bps after Warsh inflation comments. Fed Chair Kevin Warsh's Jackson Hole speech sparked a sharp rise in September rate hike probabilities, with markets pricing in nearly 50-60% odds of a hike after he signaled inflation progress was insufficient and financial conditions were not restrictive.

Personal Stakes · Est. read time 5 min

In 30 seconds: Fed Chair Kevin Warsh's Jackson Hole speech sparked a sharp rise in September rate hike probabilities, with markets pricing in nearly 50-60% odds of a hike after he signaled inflation progress was insufficient and financial conditions were not restrictive. Brad Setser argues China's true current account surplus is approximately $1.2 trillion or 5.5% of GDP—well above official figures—driven by a managed and depreciating currency that sustains export-led growth. France's debt-to-GDP ratio has doubled to 116% over 30 years, now dominating presidential election debates and prompting calls for debt cancellation from politicians. The Japanese yen weakened past 160 per dollar again despite Japan's record $96 billion intervention in the prior month, raising questions about the effectiveness of the coordinated US-Japan currency support effort.

Otherwise, we have work to do. That's our job... Our mandate... And our charge to keep'. That is not the language of a central banker preparing to sit on his hands. The market reaction was swift. One macro analyst estimated the market was now pricing a hiking cycle peaking in Q3 2027 with 2.5 hikes. A pretty big hawkish reaction. Not everyone bought the hawkish read. A macro research firm contended that Warsh didn't really lay the groundwork for a rate hike; he's catching up to the rest of the FOMC, walking the ground they already put down, and there wasn't much discussion of a productivity driven disinflation story. In other words, maybe this was less forward guidance and more housekeeping. Warsh's decision to stay strict on PCE — rather than hint at a new inflation measure — is what the market read as hawkish, and the bond market moved accordingly, with 2-year yields rising 6bps after his comments. In July, Warsh had hinted at waiting for a new inflation measure, but he took that off the table by being strict about PCE — and that is what the market interpreted as hawkish. The paradox, as one market analyst framed it: if the Fed does something about inflation (hike), bond yields can stop rising. The Fed is panicking a little more, and Bond Traders are panicking a little less. If you are a bond trader, the prospect of a Fed that actually does something about inflation is, counterintuitively, the thing that lets you sleep at night. The Fed panicking so you don't have to.

The argument is straightforward. China's reported balance of payments data understates the external surplus through a combination of methodological quirks. The IMF's current account model implies China's current account surplus would be quite different if China's real exchange rate had not depreciated over the last 6 years, even as China's surplus soared. The IMF's model implies the surplus would look quite different had that depreciation not occurred. The yuan is not floating in any meaningful sense; it is managed through increasingly heavy, often backdoor intervention that the IMF has not formally examined for China. It functions, in other words, as an independent policy variable, not an output of market forces. The implication is that without significant currency appreciation, or a massive pivot in China's growth model toward domestic consumption, the country will continue to grow through net exports. Beijing could generate one if it chose to. It has not chosen to. Gold: $4,510.90.

There is a rule in the EU that says your government debt should not exceed 60% of GDP. It is a very nice rule. France's debt-to-GDP ratio doubled over the past 30 years, climbing from below 60% to 116% of GDP. The Maastricht Treaty debt-to-GDP target is, in this context, less a binding constraint than a souvenir from a more optimistic era. The standard political response to a debt load that has roughly doubled is to argue about whose fault it is, promise vague structural reforms, and then borrow more. The country is now described, not unfairly, as a political mess caused by unsustainable debt accumulation. That is the kind of sentence that gets written about countries where the fiscal math has moved from "concerning" to "structurally defining the political landscape." And so the proposals get more creative. A French politician now wants debt cancellation. This is the stage of the debt cycle where someone looks at the number, decides it is simply too large to repay through conventional means, and suggests that maybe the number should just be smaller. You can see the appeal. If your debt-to-GDP ratio is 116% and the target is 60%, the gap is large enough that no plausible combination of spending cuts and growth is going to close it on a timeline that voters find acceptable. Cancellation has a certain elegant simplicity: the debt is a problem, so you make it not exist. The difficulty, of course, is that someone owns that debt. Bondholders tend to notice when you cancel the thing they bought. But as a campaign platform in a country that is a political mess caused by unsustainable debt accumulation, it has a certain inevitability to it.

There is a certain elegance to spending $96 billion in a single month to defend your currency and then watching it sit at 160 per dollar. You could interpret this as a policy failure. You could also interpret it as a very expensive way of buying time, which is what currency intervention usually is. The coordination angle is interesting. This is cooperative in the way that two people handcuffed together are cooperative: neither party has a great alternative. The problem is that $96 billion bought roughly nothing durable. The yen is back at 160 per dollar. Intervention without a change in fundamentals is just a central bank yelling at the ocean. Japanese yen: 160 per US dollar.

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