Wheel in the Sky
The labor market surged last month. August payrolls rose by 162,000 and July was revised higher, erasing the previously reported 23,000 decline. The move was quickly framed as renewed consumer strength despite geopolitical uncertainty and inflation pressure, the same forces cited for last month’s weakness.
While a portion of that uncertainty and downstream effects on economic fundamentals is certainly relevant, the underlying strength is better understood as a still-resilient, late-cycle expansion. In his Jackson Hole remarks, Federal Reserve Chairman Kevin Warsh emphasized several broad factors that underlie the robust economy and offered a hawkish interpretation.
While geopolitical uncertainty seems to know no bounds, Journey frontman Steve Perry may have said it best when he sang: “The wheel in the sky keeps on turnin’.” Indeed, the cataclysm of rising rates, war, and inflationary pressure remain enough to unsettle mortgage markets, but not yet enough to shake the Fed’s inclination to reengage with hikes in 2026.
The market is currently pricing a 62% chance of a September rate hike, up from roughly 30% two weeks ago. “The strong August jobs report raises the risk of a Fed rate hike in September,” said Amy Wong, an economist at Bloomberg. “It leaves the August CPI report (due Sept. 11) as the determining factor, and we expect that reading to be just borderline acceptable to the doves. The September FOMC meeting is shaping up to be a very close call.” That’s why Perry’s next line in “Wheel in the sky”—I don’t know where I’ll be tomorrow— seems to aptly describe the week ahead.
Investment is strong
Warsh described capital expenditures by companies as “the seed corn of future economic growth.” Technology companies are pouring hundreds of billions of dollars into the equipment and infrastructure required for artificial intelligence (AI). “The four-quarter change in investment in equipment and intangibles has been around 9%, its highest growth rate since 2021. More than half of the capex growth this year can likely be ascribed to the build-out related to AI,” he said. Nonresidential fixed investment climbed at an 8.5% pace in the second quarter, signaling that even if you remove the AI capex, broad investment is robust and aligned with previous mid- to late-stage expansions (Figure 1).
Profits and consumer spending are strong
“For firms in the S&P 500,” added Warsh at Jackson Hole, “profits have grown by more than 20% over the past year. Profit margins are quite elevated, relative to history. Overall equity market volatility is low. We’re staying keenly focused on market internals, watching performance across sectors.”
As Figure 2 shows, both stock prices and consumer spending are moving higher. One concern is that part of the spending strength is also appearing in revolving debt on household balance sheets. Some 0% introductory-rate incentives can encourage households to lever up, but that support will not last forever and is worth monitoring as those introductory periods expire.
Credit is fine
Warsh noted that credit spreads on corporate bonds and leveraged loans are near the low end of their historical ranges, which suggests a high level of confidence among investors. S&P Global credit default swap indexes are around all-time tights. Warsh also mentioned that the Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) shows that standards for commercial and industrial loans are on the easier end of their historical range (Figure 3). The spread has risen between survey respondents who said that financial conditions are “easing,” compared to respondents who reported “tightening somewhat.” In other words, more respondents find the market less tight.
Labor is strong
Weekly jobless claims and the unemployment rate are both hovering near post-pandemic lows. As it stands, Warsh’s comments last week—where he called the labor market “quite stable” and “consistent with full employment”—appear directionally accurate. “The labor market is showing signs of near-term cyclical strength, even as longer-term structural concerns remain,” said Adam Schickling, a senior economist at Vanguard. “This report is unlikely to materially change the Federal Reserve’s outlook on its own. The labor market remains resilient enough to keep the focus on inflation.”
Inflation is murky
Inflation had been improving toward the 2% target, but the renewed Iran war and well-covered choke points in oil-transit routes have caused a resurgence for much of 2026. To get a better picture of underlying inflation, Warsh likes to break out the 199 individual components within the Personal Consumption Expenditures (PCE) price index (Figure 4). “Over the past 12 months, 54% of goods and services in the PCE basket showed price increases above 3%. This is well below the post-pandemic highs of about 77%, but it remains well above the level of 32% in the two decades that preceded the pandemic.”
For now, most economic indicators point to an economy that is aged but is not yet caving to the typical late-cycle pressures that tip expansions into recession. That could, of course, change if the Fed resumes a hiking cycle.
As for lowering rates, Warsh will also need to contend with formidable pressure from the White House. Following the labor report, President Trump wrote: “The Fed Board, with its great new leader, must get smart – BE PATRIOTS for a change … High interest rates put the U.S.A. at a very unfair disadvantage, and I won’t allow that to happen!”
The key point is that economic cycles rarely die of old age alone; they typically need a catalyst, and higher rates remain the obvious risk. Still, current rates haven’t yet pushed the economy into a downturn, and the wheel in the sky keeps turning.
FROM THE DESK
Agency CMBS — Rates sold off for most of the week, leaving rate locks on the quieter side. Accordingly, spreads for both Fannie and Ginnie were flattish.
Municipals — AAA tax-exempt yields moved higher across much of the curve this week, as municipals continued to absorb one of the heaviest issuance calendars on record. Elevated August supply pressured intermediate and long maturities, contributing to additional yield curve steepening, while investor demand remained resilient despite the challenging supply backdrop. September reinvestment proceeds have begun flowing back into the market and are expected to provide improved technical support as the market works through continued new issuance. Municipal bond fund flows remained positive, with approximately $138 million of net inflows during the week, including $61 million into high-yield municipal bond funds. While investor demand continues to support the market, total inflows slowed materially from the prior week’s $1.4 billion gain. This development reflected a more cautious tone, as investors evaluate elevated supply levels and interest rate volatility.
The information contained herein, including any expression of opinion, has been obtained from, or is based upon, resources believed to be reliable, but is not guaranteed as to accuracy or completeness. This is not intended to be an offer to buy or sell or a solicitation of an offer to buy or sell securities, if any referred to herein. Lument Securities, LLC may from time to time have a position in one or more of any securities mentioned herein. Lument Securities, LLC or one of its affiliates may from time to time perform investment banking or other business for any company mentioned.
