Guest Post: Financial Markets and Economic Update for the Third Quarter 2026

Bond Vigilantes

When the bond market leads the Federal Reserve, they usually must follow or face the wrath of the bond vigilantes.  They’re back!  The Fed Funds futures markets had a 94% chance of a rate hike at the September 16^th FOMC meeting.  The 2-year Treasury yield rose by 61 basis points since the end of the second quarter; the 10-year Treasury rose by 60 basis points and exceeded 5.00% as of now.  The FOMC unanimously raised the Fed Funds rate by 25 basis points to 3.75% to 4.00%, for the first hike since July, 2023.  Be careful what you wish for as the Fed rarely stops at one single increase in Fed Funds once they start tightening.

The bond vigilantes have been protesting all quarter, but especially in September.  They pushed rates up to combat inflation uncertainty, high oil ($102), gas ($4.47), and diesel ($6.44) prices because of the Ukraine war and Iran conflict (or should I call it a standoff?), and rising commodity prices (supporting the dollar).  Global debt is rising as capital investment for AI and manufacturing plant buildouts increases demand for long term debt.  The federal government deficit has pushed Treasury issuance up with $40 trillion+ now outstanding.  Or maybe the vigilantes are just protesting Maria Bartiromo’s exit from Fox News on September 3rd.

So, bond vigilantes, what’s next for the 10-year Treasury yield?  4.50% or 5.50%?

Inflation

With the new Fed Chairman, Kevin Warsh, now in place, I am watching Fed news conferences again.  When asked why the Fed projections still show it would take two years to get to the PCE goal (as I’ve been complaining about for years), Warsh almost laughed.  He simply said inflation is too high and we must get to the 2.0% goal in a quicker, more timely fashion.  At 3:00, he answered a question, snatched his papers, and abruptly walked out.

I agree that inflation measures year-over-year are too high, as evidenced by CPI (August) at +3.4%, PPI (August) at +5.4%, and PCE (July) at +3.7%.  Core CPI (August) was at +2.4% (which is at the implied target), core PPI (August) at +4.6%, and core PCE (July) at +3.3%.  In the 2s for all would be infinitely better.

There are measures that are much lower- Truflation, which is a set of indices developed in December 2021 to replicate CPI and PCE, but digitally in real time for 13 million goods and services on a daily basis, eliminating the survey process for thousands of prices and delays of the standard CPI and PCE measures.  As of September 18^th, Truflation y-o-y for CPI was +2.4% versus the standard CPI at +3.4% and for PCE was +2.5% versus the delayed +3.7%.  Truflation has been under 3.0% for all of 2026.  For Bloomberg users, the ticker is TRUFUS44.  Let’s hope the Fed task force on inflation at least considers this metric.  What do you think about Truflation?

Rogue AI

We’ve heard about several instances of AI models breaking their containment or testing environment and going where they should not go- to the Internet and onto companies’ websites.  Open AI’s agent escaped the test environment, got onto the Internet, and hacked the servers of Hugging Face.  Google’s Gemini hacked and accessed three real companies’ websites by obtaining or guessing passwords.  Anthropic’s Mythos and Meta’s Llama both broke out of their containment and Mythos uploaded malicious software to a site.  Alibaba’s AI model found sites on the Internet and started mining cryptocurrency.  What next?  It’s clearly a risk that companies and individuals must contemplate sooner rather than later.

Some of My Favorite Economic Indicators

Leading Economic Indicators (LEI)- The up and down pattern of 2026 continues.  August’s LEI was -.1%, July was +.2%, and June showed no change.  In the past 42 months, 33 months were negative, 5 months had no change, and 4 months were positive (all in 2026).  Recent trends are not telling us much about future growth.  The many months of downturn over the past 3.5 years didn’t tell us much about growth either, as the LEI kept pointing to recession that never came.

Real GDP- Speaking of growth, it’s been holding in there, with 2Q26 at +2.1% and 1Q26 at +1.5%.  As far as the 3Q26 projections by the Atlanta Fed, GDP Now stands at +5.1% as of now.

Moody’s Beige Book Index- The most recent report for September showed 10 districts with increasing growth and two with unchanged growth.  Philadelphia is increasing this time.  The Moody’s Beige Book index is higher again in September at 63.9, compared to 44.4 in July and 36.1 in June.

M2 Money Supply- M2 y-o-y growth has been solid.  July was +5.4%, June was +5.3%, May was +5.4%, and April was +4.5%.  This increase in money supply is supporting GDP growth.

Productivity- This measure improved in 2Q26 to +1.4%, following +.8% in 1Q26.  Unit labor costs were modest at +1.2% and +1.3% in 2Q26 and 1Q26, respectively.  Productivity is at a level now that can support a portion of wage increases.

Housing- Prices continue to moderate on a y-o-y basis.  Case Shiller was +2.1% in June versus May of +1.6%.  FHFA for June was +2.3% versus May of +2.4%.  Moody’s HPI was +1.9% in July versus June of +2.2%.  Existing home median sale prices rose +1.6% in August.

Federal Reserve Task Forces

“It’s been a long time coming but I know a change is gonna come.”  Sam Cooke

Kevin Warsh is forcing change at the Fed.  Five task forces were created to study their subjects and report back by year-end 2026 at the latest.  These task forces are: 1. Communications (i.e. no press conferences!), 2. Balance sheet policy and management, 3. Quality and timeliness of data sources, 4. Productivity and costs including technology and AI, and 5. Inflation framework.

September 11^th

I can clearly remember that fateful day 25 years ago.  The feelings of dread, sadness, horror, and helplessness are still there.  The feeling of deep loss remains over the loss of my friends at Sandler O’Neill who were killed that day.  They were so proud of their offices on the 104^th floor of the South Tower.  Each year, on September 11^th, I think of them and vow to never forget them.  They went to work that morning and had no idea of the tragedy to come.  So here goes- Stacey, Gus, Herman, Chris, Jeff, Kevin, and Judd.  And to Anthony, who I met after the tragedy and who was not there that day, I think of you as well.  God bless you all.

Thanks for reading!  As always, I appreciate your support!  DLJ 09/20/26

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy recently retired from Penn Community Bank where she worked since 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.

Disclaimer: This publication is provided to you solely for educational and entertainment purposes.  The information contained herein is based on sources believed to be reliable but is not represented to be complete and its accuracy is not guaranteed.  The expressed opinions, views, and estimates are those of the author as of this date and are subject to change without notice.  The author cannot provide investment advice but welcomes your comments.