Weekly Comment: How Warsh’s speech could help Bessent get out of a (Jackson) Hole

Market overview

Federal Reserve Chair Kevin Warsh and US Treasury Secretary Scott Bessent have a few things in common. Both are protégés of hedge fund manager Stanley Druckenmiller: Warsh was a partner at Druckenmiller’s family office, Duquesne Capital Management; while Bessent was hired by Druckenmiller back in the 1990s when he was working at Soros Fund Management. Both were appointed to their respective positions by US President Trump. And, as Fed Chair and Treasury Secretary, both would (presumably) prefer to see lower long-term US government bond yields. All of which begs the question, did Warsh use his speech at the central bankers’ gathering at Jackson Hole to help a fellow Druckenmiller alumnus get out of a bind?

The Bessent Bind

Bessent has in recent weeks nailed his colours to the mast of lower long-term Treasury yields. Exhibit#1: his plans to “at least” double his department’s government bond buyback programme to “provide greater liquidity support” to the longer end of the US debt market. Exhibit#2: the decision by the US Treasury to sell euros to buy yen so that the Japanese authorities do not have to sell US Treasuries to prop up their currency. Exhibit#3: the Japanese plan to use the Fed’s Foreign and International Monetary Authorities Repo Facility (Fima) to provide liquidity instead of selling US Treasuries outright. And yet, despite Bessent’s efforts, 30-year yields remain at around 5.25%—although for context this is off the near two-decade high of 5.34% reached in August and compares to the 4.85% level at which they started the year. Regardless, the Bessent Bind remains: how to bring down long-term rates?

All eyes on Jackson

Now, blame for the rise in 30-year yields can, at least in part, be apportioned to Warsh himself. His minimalist approach to communications has left markets having to second-guess the Fed’s next moves on interest rates. Will he deliver the rate cuts Trump has been calling for? Or is he prepared to take the fight to inflation and raise rates? When markets are in doubt, they tend to demand a premium. For premium, read higher yields.

Then along comes the annual gathering of central bankers at the Jackson Hole Economic Policy Symposium in Kansas. Warsh had two options here: Option1 stick to his less-is-more-approach to communicating; and Option2 clarify his views and give markets a little more to go on. In the event, it seems Warsh chose Option2. By highlighting the US economy was close to full employment and that inflation remained above the 2% target, his speech had a hawkish tilt to it. Perhaps more than a tilt, as Warsh himself noted “We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do.” He then went on to discuss recent inflation prints. While these “were better than expected…they do not tell me that underlying trends have meaningfully improved.” He concluded that “on balance, I would be hard pressed to describe broad financial conditions as restrictive.”

The Druck Pack Factor

How did markets react? Yields at the short end moved higher following the speech, a nod to that hawkish tilt increasing the chances rates could rise at the next Fed rate-setting meeting—the probability of a rate hike in September has increased to over 50%. As for yields at the long end, well these too are higher than before Warsh’s speech. The theory that Warsh might do his old Druck Pack pal a favour would appear to be on shaky ground. Or is it? Yields not just in the US, but Europe, Japan and the UK, have all risen in recent days. Furthermore, a look at the charts suggests this is less to do with Warsh’s musings on Friday and more to do with a re-escalation in the US/Iran conflict over the bank-holiday weekend. This has triggered an increase in oil prices which has fed into renewed inflation worries and…higher yields.

And consider this. If Warsh does oversee a rate hike in September, then that would surely go some way to burying market concerns that he is Trump’s man. Not only this, if Warsh proves his inflation-busting credentials, then that ought to go down well with bond markets and eventually lead to lower yields at the long end. Now that would help get Bessent out of his bind.

Weekly market moves:

The MSCI All Country World Index (MSCI ACWI) ended the week 0.3% higher, up 15.0% YTD.

United States:

Strong earnings results from artificial intelligence (AI) bellwether Nvidia gave technology stocks a boost which helped US equity markets look beyond high bond yields and Middle East tensions—the main US stock index rose 0.5% (+13.0% YTD).  Not much to choose between growth (+0.3%) and value (+0.4%) over the course of the week. Small caps were the outlier courtesy of a 1.5% decline. YTD, growth still has a way to go to catch up with value (+23.8% YTD) and small caps (+20.8% YTD).

As well as Warsh’s speech, bond markets had to digest a higher-than-expected Personal Consumption Expenditures (PCE) reading.  Headline PCE rose 0.2% in July compared to the previous month and was up 3.7% on an annual basis. The data helped feed the growing narrative of a September rate hike. Short-dated Treasuries therefore underperformed the long end with the yield on the 2-year note up 11 basis points to 4.35% (up 87 basis points YTD). The 10-year Treasury yield edged two basis points lower to 4.72% (up 55 basis points YTD).

United Kingdom:

A gain is a gain! The UK large-cap index closed the week up just +0.1% (+11.7% YTD). Mid caps fared better rising 1.0% (+13.6% YTD). Sterling gave back some of its recent gains, ending the week at US$1.35 compared to US$1.36 previously. Like equities, gilts barely budged. The yield on the 10-year note was unchanged at 5.06% (up 58 basis points YTD)—although post weekend yields have risen in response to rising Middle East tensions.

Europe ex UK:

The MSCI Europe ex-UK Index matched the UK’s 0.1% gain (+12.8% YTD) as mixed economic data largely cancelled each other out. On the one hand, economic sentiment, as measured by the European Commission’s Economic Sentiment Indicator (ESI), improved for a fourth successive month, while the German economy expanded by 0.3% in Q2 compared to the 0.2% expected.  On the other hand, France’s economy failed to grow in Q2, while inflation rose 2.4% in August compared to 2.1% in July. These conflicting forces were reflected at the national level with Germany’s stock market adding 1.7% (+8.5% YTD) and France’s falling 1.0% (+5.8% YTD). Elsewhere, Italy’s main benchmark ticked 0.1% lower (+20.6% YTD) while Switzerland’s closed down -0.4% (+11.7% YTD).

Like sterling, the euro gave back recent gains, ending the week at US$1.16 compared to US$1.17 previously. Finally, the 10-year German bund yield rose two basis points to 3.28% (up 42 basis points YTD).

Important information

Investors should remember that the value of investments, and the income from them, can go down as well as up and that past performance is no guarantee of future returns. You may not recover what you invest.

This material is a marketing communication provided for information purposes only and does not constitute independent investment research. References to financial instruments are for general information purposes and are not subject to requirements applicable to independent investment research.

Any references to securities or financial instruments should not be regarded as a personal recommendation, or as an offer, solicitation or invitation to buy or sell any financial instruments. The views expressed are those of the authors at the time of publication and are subject to change.

This material does not constitute tax, legal or accounting advice. You should seek independent professional advice appropriate to your individual circumstances before making any financial decision or engaging in any transaction.

To listen to all the past Weekly Comment podcasts click here or subscribe via the apps below: