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The S&P 500 gained 2.7% in August, as resilient corporate earnings outweighed concerns about inflation, deficits, and monetary policy.
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Long-term Treasury yields rose, with the 30-Year Treasury reaching its highest level since 2007, creating headwinds for borrowers and bondholders.
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The Treasury expanded its long-term Treasury buybacks, providing temporary relief for long-term rates before yields moved higher again.
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The Fed continued to prioritize inflation concerns, with Warsh signaling that persistent price pressures could warrant further tightening even as the workforce shrinks.
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Two forces are sustaining inflation: weaker supply from tariffs and energy disruptions, and rising demand from significant data center investment.
In August, underlying tensions in the stock and bond markets were overshadowed by robust corporate earnings, leading to an S&P 500 Index return of 2.7% and a year-to-date increase of 13.1%. The underlying concerns included sticky inflation, expansive deficit spending, and seemingly contradictory messages and actions from the Federal Reserve (Fed) and Treasury. The 30-Year Treasury yield rose from 4.9% at the end of June to 5.3% by August 18, the highest level since mid-year 2007. Higher rates are not only costly to the U.S. Government, as it pays more to bondholders, but also directly impact mortgage rates, making housing even more unaffordable. They also drive down the value of existing bonds with lower coupons, which helps explain why diversified bond portfolios such as the U.S. Aggregate ended the month close to flat for the year.
On August 19, Treasury Secretary Bessent announced the department would expand its buybacks of long Treasuries from $2 billion to $4 billion. While seen as an effort to tame long-term rates, it caused only a momentary dip. Not only was the increase a minor blip given the size of the Treasury market, but market participants widely dismissed it as a political maneuver. A similar signal of administration concerns over higher rates was Bessent’s efforts to convince Japan to shift Treasury assets to a Federal Reserve lending facility rather than sell them outright.
Meanwhile, Federal Reserve Chairman Warsh spoke at the Fed’s Jackson Hole meeting. Investors hoping weakness in the job market would keep rate hikes at bay were not reassured by Warsh’s assessment that the workforce is shrinking. Instead, he focused on inflation and left the strong impression that the Fed would need to take action (raise rates) if prices continued to rise. He has also remained committed to shrinking the Fed’s balance sheet even as the Treasury increases its own purchases.
Inflation relief requires combating two central pressures: diminished supply and increasing demand. Supply weakness stems directly from higher tariffs and the Iran war, which restricts oil and refinery products through the Strait of Hormuz. Demand is largely a product of the data center boom, which is projected to continue into 2027 and beyond. Spending a trillion-plus dollars on these construction projects has a measurable effect on the cost and availability of labor, heavy equipment, and materials.
Turning to investment implications, we expect inflationary pressures to persist. We are also exercising caution about the most optimistic projections for the coming age of AI. One concern is the circularity of the AI spend among chipmakers, hyperscalers, and leading AI developers. Another is the frantic pace of the build, which implies a sort of arms race in which the players are self-admitting the potential for winners and losers. On this note, a positive trend for the kind of diversified portfolios we favor is the market’s continued breadth away from AI megacaps into this year’s strong sectors, including Health Care, Materials, and Energy.