Strategy commentary cont'd: Hawkish central-bank rhetoric compounded the sell-off into month-end. The ECB's Isabel Schnabel flagged that further tightening would be necessary given inflation was unlikely to return to target, and Fed Chair Kevin Warsh delivered a hawkish speech at Jackson Hole, reiterating the Fed's focus on above-target inflation and signalling there was "work to do", which flattened yield curves.

By month-end the market was pricing a 65% chance of a hike at the September FOMC meeting, a notable shift given the political calendar. Commentary from the ECB and the Bank of Japan was similarly firm, leaving markets almost fully pricing September hikes from both.

Yields consequently finished August higher, although the moves were much smaller than July's. The 10-year US Treasury yield increased 4bps to 4.75%, leaving it 52bps above its level a year earlier. German 10-year Bund yields climbed 12bps to 3.32%, extending their highest levels in more than a decade, while 10-year UK Gilt yields were little changed at 5.06%. French OAT yields rose 18bps to 4.18% and Italian BTP yields 13bps to 4.15%, with the OAT/Bund spread widening 6bps to 85bps and the BTP/Bund spread 1bp wider at 83bps. Japanese 10-year government bond yields increased a further 15bps to 2.94%, 134bps higher than a year ago.

The battle between the bond market and policymakers over the long-term cost of capital remained the dominant theme. Warsh, operating under what we have described as an implicit contract with President Trump not to lift the policy rate ahead of the November mid-term elections, has instead encouraged higher term premia and an upward repricing of long-term yields.

The 30-year Treasury yield has done the heavy lifting, spiking to its highest level in almost two decades, and dragging the 30-year fixed mortgage rate, which prices off that benchmark, up roughly 70bps from its February lows near 6% to about 6.7%. Warsh has, in effect, foisted de facto rate hikes on American borrowers while leaving the cash rate untouched, which we regard as the least worst policy solution given the constraints.

The US Treasury has been pulling in the opposite direction. Having joined the coordinated yen-buying operation at the end of July, the first since 1998, which it funded by selling euros out of US reserves to avoid putting upward pressure on Treasury yields, Bessent's buyback expansion lifts purchases of 10- to 30-year bonds from US$2bn to US$4bn or more per operation, funded by skewing new issuance towards short-term bills. In direct opposition to Warsh's stated preference for letting markets set the price of money, this is artificial yield suppression by another name, as Bessent's own mentor, Stanley Druckenmiller, has publicly protested.

Investors have begun to fret that if the Fed and the Bank of Japan fall too far behind the curve, they may have to lift rates much more aggressively to expunge entrenched inflationary pressures. History suggests that melees between markets and manipulators tend not to end well for the latter.

The inflation backdrop justifies that concern. Underlying US inflation has been running at around 3.5% on a six-month annualised basis (3.3% year-on-year), well above the Fed's 2% objective, and core inflation has now been stuck above target for five and a half years. Our Taylor Rule modelling continues to imply the policy rate should sit 75-100bps above the current 3.50% to 3.75% range, and we think a US hike before year-end remains likely. A belated and globally synchronised hiking cycle is already under way across Australia, New Zealand and Europe, and in all likelihood the US will join it.

One driver is a theme we have long flagged: artificial intelligence is proving highly inflationary in the short to medium term. There is no imminent deflationary wave. Instead, AI is propagating an enormous spending and demand shock that has created bottlenecks throughout critical technology supply chains, bidding up the price of chips, memory, compute and almost anything associated with data centres. For the first time in modern history, technology costs are contributing to goods inflation rather than subtracting from it.

Compounding the squeeze are surging global military spending, profligate public spending, weak productivity outside the US, and never-ending supply-side shocks from the wars in Iran and Ukraine. This is why central banks have failed to hit their price-stability targets since the pandemic.