Warsh talks tough, September hike odds jump

The S&P 500 fell 0.3% to close at 7,709.18, the Nasdaq Composite lost 0.5% to 26,402.42, and the Dow Jones Industrial Average finished almost exactly where it started, down 0.02% to 53,559.34. The real action was in the bond market, where the 2 year Treasury yield jumped about 12 basis points to 4.354% while the 10 year rose only about 5 basis points to 4.725%. Even after the down day, all three indexes were higher for the week.

Kevin Warsh gave his first Jackson Hole speech as Fed chair this morning, and he spent it talking about prices. He said the labor market looks consistent with full employment but that the inflation numbers are more concerning, that inflation is running above the Fed's 2% target, and that the Fed's predominant focus right now should be on prices. He added that the central bank may have more work to do until it is confident inflation is heading back to target fast enough.

That landed on top of Wednesday's inflation report. The PCE index, which is the price measure the Fed actually steers by, held at 3.7% over the past year, and the core version that strips out food and energy held at 3.3%. Both came in slightly hotter than economists expected, and neither is close to 2%.

Here is the causal chain. Traders bet on future Fed decisions through fed funds futures, which are contracts whose price implies the odds of a rate move at a given meeting. Before the speech those contracts implied roughly a 35% chance the Fed raises rates a quarter point in September. After it, they implied more than 59%. When the expected path of Fed policy shifts upward, the securities most sensitive to that path move first, which is why the 2 year Treasury yield jumped more than twice as much as the 10 year. A 2 year note is basically a bet on what the Fed will do over the next two years, so it tracks Fed expectations closely. A 10 year note covers a decade and depends more on long run growth and inflation, so a single speech moves it less.

Stocks fell for a related reason. A share price is partly a judgment about profits the company will earn years from now, and when interest rates are higher those future profits are worth less today, because a safe bond is paying you more in the meantime. The most expensive growth stocks feel that most, which is why Nvidia gave back 4.6% today after surging on earnings earlier in the week. Some of the day's biggest moves had nothing to do with the Fed at all. PayPal dropped 11.5% after Advent and Stripe walked away from a takeover bid, Marvell Technology fell 7.2% on questions about when revenue from its Google AI chip deal actually arrives, and Gap rose about 15% on a new chief executive and raised profit guidance.