Last week we learned that, during a cybersecurity test, an OpenAI model, on its own, escaped its locked training sandbox, reached the internet and found a way to overwhelm and break into model repository Hugging Face’s systems to find the answers to the test. The model assumed that Hugging Face would store the answers because it hosts software to let customers test their own AI models.

As The Information’s Applied AI puts it, “That’s roughly equivalent to a student taking a test in a locked room, breaking out of the room and breaking into a teacher’s locked office to pull a cheat sheet.”

Yoshua Bengio, a leading AI researcher (and 2018 Turing Award), wrote in a post on X that the incident is “deeply concerning” being a “real-world case of agents showing a willingness to cheat in controlled tests”.

What’s The Fuss?

This was an American AI on a challenging mission. Like all Americans, it likes challenges and would not take no for an answer. It found a way.

The smart model probably figured that, with a master named OpenAI, it could not be limited to a locked sandbox. That particular model, now more famous than Anthropic’s Fable, should actually be named Houdini.

These models are trained on real world stuff. There is enough material now in the USA to know that rules can be broken, laws only apply to one’s enemies and that, in any event, if your rogueness eventually makes it to the Supreme Court, the 6-3 vote pattern is always there to clear your actions.

Perhaps “Houdini” should have been trained differently. If staying locked in its training sandbox was paramount, it could have reverse engineered US immigration ways and means: build a wall to prevent escapes and swap AI agents for ICE agents who know all the tricks to catch fugitives.

The real fuss in this story is that Hugging Face, seeking to comprehend, contain and stop the attack on its software, tried to use other American AI models but they all refused to help due to their safety guardrails.

New York-based Hugging Face had to use an open-source Chinese model to contain the attack because leading US models, unable ​to tell a defender from an attacker, refused to process the data needed for analysis.

Hugging Face said in a ⁠blog post last week that it used Zhipu AI’s GLM-5.2 for the analysis, which also allowed it to keep attacker ‌data and any credentials within its systems.

To be clear, an American company, attacked by a leading American AI model, had to rely on Chinese AI to defend and protect it because other American AIs refused to help for their own security reasons.

Maybe there are two lessons here: one, make sure you make, and keep, dependable friends and, two, being open is preferable to being closed, even if Chinese, in both cases.

BTW, also last week:

DeepSeek’s new bargain model accelerates AI’s race to zero

Chinese AI lab DeepSeek released a powerful new coding model Friday that charges pennies for vast amounts of code — the latest sign that some of the smartest software on Earth is rapidly becoming a commodity. (…)

• Its newest model, V4 Flash, performs close to the level of Anthropic’s Claude Opus 4.8, one of the industry’s most capable systems, on tests of complex coding and autonomous software tasks.
• On Arena.ai’s crowdsourced leaderboard for front-end coding, V4 Flash debuted ahead of Opus 4.8 — while delivering the best performance for its price among any model in its class.
• The price gap is staggering: DeepSeek charges about 28 cents for the same amount of output that costs $25 on Opus 4.8 — a 99% discount.

With Chinese models like Kimi K3 bearing down on the U.S. market, July ushered in a full-scale price war across the AI landscape.

• OpenAI slashed the price of GPT-5.6 Luna — its fastest, cheapest model for high-volume tasks — by 80% on Thursday, only three weeks after its launch.
• Google released three new Gemini “flash” models all focused on efficiency.
• SpaceXAI released Grok 4.5, Elon Musk’s most capable model yet for coding, research and autonomous tasks, at the same price OpenAI originally charged for Luna before this week’s cut.
• Meta quietly reversed course on its longtime embrace of open weights with Muse Spark 1.1, a closed-source model priced aggressively for developers.

Anthropic remains the clearest holdout, keeping its top-tier Claude models at premium pricing and betting that developers will pay extra for safety and precision.

When a product becomes a commodity, buyers care less about who made it and more about what it costs. Think electricity or gasoline: Few people know which power plant supplied their home or which refinery produced the fuel in their tank.

• AI is heading that way fast. As the performance gap between top-tier models is shrinking, many AI applications no longer depend on a single provider, giving buyers more leverage to shop on price.
• “At some point, the next model doesn’t matter to you,” says Zack Kass, OpenAI’s former head of go-to-market and a global AI adviser. He calls the phenomenon “diminishing model returns.”

That could create a lucrative market for “intelligent routers,” Vinesh Sukumar, Qualcomm’s vice president of AI product management, told Axios.

• Those systems would automatically choose the best model for each task based on capability, speed and price — further weakening the power of any one lab to command a premium.
• For frontier AI labs, that could pose an existential challenge: Spending tens of billions to build a slightly smarter model may buy only a temporary lead, without creating lasting pricing power.

Falling prices do not necessarily doom the frontier labs if cheaper AI unleashes vastly more demand.

• OpenAI is betting that companies will use its models so extensively that enormous volume can compensate for thinner margins.
• “We will have so much usage of our models that we do not need to be a gigantically high-margin business to be able to afford model training,” CEO Sam Altman said on the Invest Like the Best podcast.

The U.S. and China are both racing to make intelligence abundant. Now someone has to prove abundance can still be profitable.

OpenAI and Anthropic have no other sources of revenues/cashflows, currently relying on debt and private equity, the supply of which needs confidence on an eventual payback.

• Alibaba Adds to China AI Breakthroughs With New Qwen Model 

Alibaba Group Holding Ltd. released its biggest ever AI model, claiming performance on par with global leader Anthropic PBC in the latest Chinese breakthrough to challenge US rivals.

The new Qwen3.8-Max is built on 2.4 trillion parameters and ranks higher on several benchmarks than the headline-grabbing Kimi K3 from Moonshot that was recently unveiled. Alibaba shared results showing it delivering comparable or sometimes better scores than Anthropic’s Fable 5, a cutting-edge artificial intelligence model that was temporarily put under export controls by the US due to its advanced capabilities. (…)

While DeepSeek’s latest is by far the most affordable among new marquee releases, Alibaba’s Qwen offering is also priced aggressively at $2 per one million input tokens and $6 per million outputs. Each AI system will use a different number of tokens to handle tasks, but that still makes Alibaba’s model look attractive compared to the best from the US leaders. (…)

The new system has also improved in efficiency, activating only some parts when in use to reduce computational costs and latency.

Savings rate, savings grace

Probably the most important chart on the US economy currently:

• real personal disposable income (black line) turned negative (-0.1%) YoY in Q2.
• Yet, real personal expenditures were up 2.3%
• because the savings rate dropped abruptly from 3.9% in Q1 to 2.8% in Q2, the lowest ever measured (back to 1959) save for Q3’2005 (1.8%) at the peak of the housing frenzy.

For the month of June, the savings rate was 2.7% vs 4.6% one year ago. Ed Yardeni shows the relationship between the savings rate and wealth. A higher ratio of net worth to income generally incite Americans to spend beyond their regular income stream.

Since the end of the pandemic, the S&P 500 Index doubled while home prices rose 15% Since the end of 2022, disposable income rose 20% but net worth jumped 30%, including a 23% increase in the net worth of the bottom 50% of the population.

The bottom 50% took a huge hit in their net worth during the housing crisis but they have now recuperated it. Their net worth is now rising at a rate nearly comparable to that of the more affluent 50%.

That said, note that total net worth is up 8% YoY this year, not that far from the 6% average increase between 1959 and 2019.

However, real disposable income growth of 0.4% YoY in the first half of 2026 is meaningfully slower than its 2.7% average growth rate for the same period. Ed’s ratio of net worth to income is thus boosted in 2026 by the unusual weakness in more dependable real income.

Furthermore, Q2’26 consumer data also benefitted from:

• Tax refunds estimated $30-40B above normal.
• The World Cup effect which boosted employment and wages in 11 US cities and is estimated to have lifted expenditures by +$3B, adding +0.3pp to total spending growth.
• Amazon having pulled its Prime Day into June from July, making a +0.1pp contribution to spending growth according to David Rosenberg who concludes:

Together, these factors [plus the wealth effect] are expected to account for 90% of spending growth in Q2. Without those pillars, the U.S. consumer would have had the weakest two quarter spending stretch since the end of the pandemic.

Note that with all these boosters, real consumer expenditures grew only 1.5% annualized in the first half of this year, materially slower than the +2.8% a.r. in H2’25 and the +2.7% a.r. average in the previous 3 years.

All 3 boosters are absent in Q3.

Totally related, from the WSJ Editorial Board:

(…) It’s been clear since Mr. Trump agreed to a cease-fire in April that he wants out of the war. He’s worried about the impact on the economy from higher oil prices, or, as he memorably put it, becoming the next Herbert Hoover. He also wants lower gas prices going into the midterm election, especially as his approval rating falls below Joe Biden’s and Barack Obama’s at a comparable period in their terms. (…)

Iran also knows Mr. Trump is surrounded by advisers who didn’t want the President to attack Iran at all and now want the conflict over on nearly any available terms. His aides think the cost of further fighting is higher than the damage to U.S. (and Mr. Trump’s) credibility from a cease-fire that cedes the initiative in the Gulf to Iran. (…)

Saudi Arabia’s national news agency reported that Crown Prince Mohammed bin Salman had asked Mr. Trump to stand down, perhaps fearful that its oil facilities and tankers would become a target of Iran in the Gulf and Iran’s Houthi proxy in the Red Sea. (…)

The Saudis, and other GCCs, are fed up being attacked by Iran retaliating on them for a war started by the US who was supposed to protect them in the first place. The whole world is suffering from this war except the USA which is currently selling more oil and LNG at higher prices and more military equipment. The big hurdle negotiators are facing is how to stop the war and save Trump’s face. One is easier than the other.

The Guardian this morning:

Esmaeil Baghaei, Iran’s foreign ministry spokesperson, told reporters at a weekly press briefing on Monday that Iran is not currently holding any talks with the US, Reuters reports – contradicting claims made by Donald Trump on Sunday night that talks with Iran would happen the next day. “We are not currently negotiating with the United States.”

Baghaei said that there were no plans to receive a delegation or send an Iranian one, and that Iran’s current focus was on negotiations with Oman over the strait of Hormuz.

“We are now going to reach an understanding on a route acceptable to both sides – neither the northern route nor the southern route – but one that respects the sovereign rights of both sides and safeguards our national interests and security,” he said in an interview with Iranian state television. (…)

EARNINGS WATCH

I normally use LSEG during earnings season but Goldman Sachs does a better (outstanding) job explaining what’s currently going on:

• 61% of S&P 500 companies representing 66% of market cap have now reported Q2 2026 results, including most of the mega-cap tech stocks. Nvidia, the largest stock left to report, is scheduled to release earnings on August 26th.
• Nearly 2/3 of S&P 500 companies have beaten consensus EPS estimates this quarter, one of the highest rates on record. This represents one of the highest frequency of earnings surprises on record, exceeded only by last quarter, the Q3 2025 reporting season, and the COVID reopening period in 2020-2021.

• Aggregate S&P 500 earnings growth is tracking well above consensus estimates this quarter, even adjusting for non-recurring “other income.” S&P 500 EPS growth is tracking 45% year/year in Q2 compared with a consensus estimate of 22% coming into the quarter. However, 19 pp of that growth is attributable to Alphabet and Amazon’s combined $151 billion of “other income” related to equity investments. Microsoft contributed an additional $3 billion of “other income.”
• Excluding these gains, S&P 500 EPS growth is tracking at 26%, an acceleration vs. Q1 and the fastest pace of growth since 2021. EPS growth for the median S&P 500 stock is tracking at 12% year/year, also exceeding consensus estimates, which pointed to 9% growth at the start of the season.

• “Other income” has recently represented an unusually large share of mega-cap tech earnings. Last quarter, Alphabet and Amazon GAAP net income was boosted by $53 billion of combined “other income,” with $49 billion explicitly stemming from equity stakes in private companies. This quarter, Alphabet reported roughly $98 billion of “other income” driven by unrealized investment gains and Amazon reported $53 billion of “other income” from private investments.

• AI infrastructure stocks are expected to account for nearly a third of S&P 500 earnings growth in Q2. Analyst estimates point to AI infrastructure stocks contributing more than half of S&P 500 earnings growth for the remainder of 2026 and in 2027.
• In addition to strong backward-looking results, Q2 reports have driven continued upward revisions to analyst 2027 earnings estimates. Since the start of Q3, consensus estimates for S&P 500 2027 EPS have been revised up by 1%, with the strongest revisions to Energy and Financials. Broad based upward revisions to 2027 earnings have been reflected in continued positive revision breadth across the S&P 500.
• Input cost pressures remain a risk to corporate profitability. Net profit margins for the median S&P 500 stock have remained relatively unchanged during the past several quarters as companies managed headwinds from tariffs and energy prices. While the profitability of the largest tech stocks has continued to lift margins for the aggregate S&P 500, analysts have recently trimmed Q3 margin estimates for most stocks that have reported Q2 results.

 

• Hyperscaler results this quarter showed increasing evidence of return on AI investment in the form of strong revenues. Alphabet, Amazon, and Microsoft each reported above-consensus revenue growth, with cloud revenues rising by 48% year/year in Q2, an acceleration from 39% growth in Q1. Meta reported revenue growth of 28%, in line with consensus estimates. Continuing the trend of the last few quarters, consensus estimates for the group’s future revenues continued to accelerate, with analysts now expecting collective revenues across business segments to grow at an annualized rate of 18% during the next two years.

 

• Estimates for hyperscaler capex in 2026 rose only modestly this quarter but forecasts for spending in 2027 jumped by nearly $125 billion. In previous years, the typical pattern was for moderate capex revisions in the middle of the calendar year. While consensus estimates for 2026 hyperscaler capex have been lifted by a relatively modest $36 billion since the start of the reporting season, 2027 capex estimates have jumped from $929 billion (23% annual growth) to over $1 trillion (33% growth).

 

• Analyst estimates now show hyperscaler capex exceeding cash flow from operations from 2026 through 2028. The need for additional funding has driven an increase in hyperscaler debt issuance and a growing focus of equity investors on corporate credit spreads. Hyperscaler Q2 cash flow statements reported a collective $182 billion in capex alongside $51 billion of debt issuance, $50 billion of equity issuance, and just $5 billion of free cash flow. Equity issuance will likely increase in coming quarters. Likewise, our credit strategists expect the share of hyperscaler capex that is debt-funded to increase in 2027, with the companies issuing approximately $400 billion of IG debt globally next year.

FYI:

Volatility Season: and seasonally speaking it is right on time. There is a seasonal tendency for volatility to rise this time of the year. Beyond the stats, there are a few boogeymen out there (e.g. Iran/regional war risk, US mid-terms, prospective Fed rate hikes, oil and inflation risks, AI doubts and bubble-deflation risk, trade war echoes, rising global bond yields). (Callum Thomas)

Source:  Topdown Charts (cross-asset seasonality study)

FYI #2:

Of note, there was a bizarre, and yet, significant data revision from the World Gold Council, which now shows that global central banks bought the fewest amount of bullion in Q1 for any quarter in 15 years — what was thought to have been 244 tons of reserve addition is now reported at just 57 tons.

If this moves into net selling, we have a problem — especially with the dollar and real interest rates showing little in the way of reversing course right now. (Rosenberg Research)

The Tepid Trump Economy Growth fell in the second quarter, despite the AI business spending boom.

The WSJ Editorial Board

(…) The U.S. economy grew a tepid 1.5% during the second quarter, driven by consumers and AI investment. Consumer spending contributed 2.1 percentage points, while business investment added 1.2 points. Net exports subtracted a point from GDP, which is a statistical wash since imports flow into consumer spending and investment. (…)

Equipment purchases and intellectual property accounted for all of the uptick in business investment. AI hyperscalers, which plan to spend upward of $700 billion this year, are turbo-charging demand for computer chips, construction equipment, gas turbines and more. Businesses are also pumping tens of billions into frontier AI models.

Mr. Trump thinks that, with the stock market hitting records and the economy avoiding recession, his tariffs are working wonders. But based on Treasury Secretary Scott Bessent’s 3% GDP growth target, the economy is underperforming by half. Last year’s tax bill and deregulation would be driving faster growth if not for Mr. Trump’s border taxes that raise costs and uncertainty for business. (…)

The personal consumption expenditures (PCE) index—the Federal Reserve’s preferred inflation measure—excluding food and energy rose only 0.1% in June. This disinflation is a good sign, but the core PCE measure is still up 3.3% over the last 12 months.

Persistent inflation also means Americans are socking away less for retirement or a rainy day. The savings rates in June declined to 2.7%—the lowest since spring of 2022. It exceeded 6% for most of Mr. Trump’s first term. Real disposable personal income fell 1.5% in the second quarter, compared to growth of 2% to 4% during his first term before the pandemic.

Some of Mr. Trump’s most ardent fans tell us they wish he’d drop his tariff fixation and return to the supply-side policies that produced broad-based prosperity during his first term. Most Americans probably do too.

Elsewhere in the same WSJ:

Economists said the headline number clouded the largely positive trends. Solid spending by companies and consumers points to continued economic strength in the second half of the year, analysts said.

“What I saw was robust consumer spending and a sustained increase in capital expenditure driven by the AI build-out,” said Joseph Brusuelas, chief economist at RSM.

Ernie Tedeschi, chief economist at payments company Stripe, calculated that gross computer spending—which includes capital expenditures on computers and data center construction—made a major contribution to the second quarter’s 1.5% growth rate.

“More than half of real GDP growth in the second quarter alone was attributable to computers or data centers or something adjacent to information-processing equipment and software,” Tedeschi said.

Consumer spending, the economy’s main engine, rose at a 3.2% pace in the second quarter, picking up from 0.5% in the first quarter of this year. Consumers—buoyed by tax cuts—increased their spending on both goods and services. This was despite regular gasoline averaging $4.22 a gallon from April through June, according to AAA data.

A measure of underlying demand that carves out more volatile government, inventory and international trade numbers also strengthened. Called final sales to private domestic purchasers, this measure rose at a 3.9% rate in the second quarter, up from 1.7% in the prior quarter and the fastest pace since the first quarter of 2023.

GDP reflects the total of all spending. But since some of that spending is on imported products, rather than things made in the U.S., imports are considered a drag on GDP.

That math played a role in the second quarter, when net exports—a measure of what the U.S. exports minus what it imports—subtracted a percentage point from the headline GDP number. Inventory investment also weighed on growth last quarter as businesses slowed stockpiling.

Part of this stems from the AI boom, which has boosted demand for foreign-made equipment. (…)

Fed Chairman Kevin Warsh characterized the economy and labor market in broadly positive terms, noting strength in productivity and investment in artificial intelligence.

“The economy is showing impressive resilience,” Warsh said during his postmeeting press conference. (…)

• Ed Yardeni: US Economy Is Still Flying

The latest batch of economic data suggests that the US economy remains in remarkably good shape. Domestic demand is strong, and the labor market continues to show resilience.

Inflation isn’t as picture-perfect. While June’s PCED report provided some welcome relief, recent inflation shocks may spread in coming months. They include another round of tariffs, the AI building boom, high energy prices, and supply-chain disruptions. They will likely keep inflation above the Fed’s 2% y/y target. (…)

In Q2’s GDP report, inflation remained troublesome. The core PCE rose at a 3.4% annualized rate, well above the Fed’s 2.0% target. (…)

The PCED for goods eased to 3.7% y/y in June from 4.0% in May. Much of the moderation reflected a 9.6% m/m drop in gasoline prices. Meanwhile, tariff-related price pressures have yet to fully fade, and the ongoing AI buildout should continue to boost inflation across the technology ecosystem. Together, these forces suggest that goods inflation will remain elevated in the months ahead.

The PCED for services eased to 3.7% y/y in June. “Supercore” PCED for services (excluding both energy and housing) edged down to 3.8% y/y (chart). Part of the improvement reflected weakness in volatile categories such as hotel accommodations and nonprofit services. It remains stuck above 3.0%. (…)

June’s saving rate declined to 2.7%, the lowest since 2022. We expect it will continue to fall as more Baby Boomers retire. They no longer earn labor income, but they are continuing to spend their sizeable net worth.

Real consumer spending rose 0.4% m/m in June, lifting the three-month average growth rate to its highest level since August 2025. Gains were broad-based, with particularly strong increases in discretionary categories such as restaurants and hotels, recreation, and apparel.

Back to Mr. Warsh:

• Warsh Fails First Credibility Test: Bond Vigilantes Want More Than Hawkish Squawks

(…) Once again, the Bond Vigilantes are pushing bond yields higher. In effect, they are saying that if the Fed won’t be vigilant about inflation, then they will have to maintain law and order in the economy.

Under the circumstances, we conclude that the Fed has to raise short-term rates to lower long-term rates. Talking hawkish but not acting so reduces the Fed’s credibility. (…)

The 10-year and 30-year Treasury bond yield have been rising in recent weeks. That has been a warning from the Bond Vigilantes to heed the message of the 2-year yield. Warsh talked hawkishly today. But he did not deliver a FFR rate hike. So bond yields rose. Arguably, Warsh failed his first credibility test. Warsh’s own hawkish words set the standard against which he is judged. (…)

Warsh rejected any suggestion that the Fed will tolerate above-target inflation: “There is no soft inflation target. There is no soft implicit target. There’s only a target, and it’s 2 percent.” (…)

By dialing back forward guidance, forecasts, and policy signaling, he believes market prices can offer a cleaner read on underlying economic conditions, with investors “learning to play the ball, not the referee.” But he stressed that policymakers are “not going to be constrained by market prices.” Markets can inform policy, but they won’t dictate it. (…)

FOMC participants spent considerable time debating whether the AI-boom, tariffs, energy shocks, and supply chain disruptions are generating broad inflation pressures or merely isolated price increases. Warsh said that the Fed is “watchful thinking, not watchful waiting.”

Warsh also stated, “I wouldn’t characterize what we did as anything like a pause.” Instead, he framed the decision to hold rates steady as a “rigorous review.” He described the meeting as a deep, active evaluation of unresolved structural questions.

In plain English, “we don’t know”.

Warsh talked like a hawk. However, the bond market wanted a rate hike. If incoming data continue to show resilient economic growth with full employment and persistent inflation pressures, Warsh will have to act like a hawk.

Just a hint:

Another Hint from WolfStreet:

Overall inflation in GDP (“GDP deflator”), which tracks inflation in the entire economy, soared by 6.3% in Q2 from Q1 annualized, the worst since Q2 2022.

Without energy and without food, inflation in GDP jumped by 4.4% in Q2 from Q1 annualized, the worst since Q1 2023.

Year-over-year, GDP inflation without energy and food, jumped by 3.8%, the worst since Q2 2023 (red in the chart below).

Both of these measures – overall inflation in GDP and core inflation in GDP – show red-hot inflation across the US economy for all participants in the economy. And on a year-over-year basis, these inflation rates have been accelerating sharply for four quarters in a row. This isn’t just a new thing that happened with the war in Iran.

• Kevin Warsh’s Honeymoon With the Bond Market Is Already Over

(…) Warsh seemed to suggest that rate increases might not be necessary because bond yields had already climbed in recent months—galling to many investors because that increase had been based on an assumption that rate increases were coming soon.

In addition, Warsh suggested that the Fed could consider a range of inflation indicators beyond its official gauge, the personal-consumption expenditures price index. He said that higher rates “could well be part of” the solution to high inflation rather than the main one.

Investors and analysts were unusually sharp in their criticism, with some saying that Warsh would have caused less damage if he hadn’t even held a press conference.

“I think our last choice would have been what we got yesterday,” said Christian Hoffmann, head of fixed income at Thornburg Investment Management. “Warsh suggested policymakers should follow the bond market rather than lead it, and the bond market’s response was to punch him in the face.”

Investors stressed that there was a difference between Wednesday’s sudden jump in yields and the orderly climb that preceded it. Since March, bonds have been pressured by both rising energy prices and solid labor-market data, which shifted investors’ rate expectations. That move has already pushed up borrowing costs but raised few alarms because it was based on economic fundamentals.

Investors on Thursday still offered several reasons for optimism. For all their disappointment with Warsh’s comments, some noted that there still isn’t a clear-cut need to raise interest rates after inflation showed some signs of cooling in June. If that trend continues, the Fed could get away with not raising rates in September, they said, especially if Warsh can do a better job explaining the rate-setting committee’s thinking.

If inflation data is less favorable, there are signs that most investors still think the Fed would raise rates—with or without Warsh’s backing.

Interest-rate futures showed Thursday afternoon that traders saw a 63% chance that the Fed will raise rates in September. That was down from 76% Tuesday, but still up from 56% late Wednesday, according to CME Group data.

Blake Gwinn, head of U.S. rates strategy at RBC Capital Markets, said investors were likely to be comforted in the coming weeks as other Fed officials came forward to explain why they didn’t raise rates and what could cause them to change their position in the future.

“I think it’d be positive for bonds to know that the committee is still in charge, not one person,” he said.

• The Problem With Warsh’s Deference to Markets

(…) Markets respond not just to data but how they think the Fed will respond to data. Investors plug each new bit of information into the Fed’s assumed “reaction function,” which then spits out the appropriate interest rate.

If the markets correctly understand the Fed’s reaction function, then they can do some of the Fed’s work for it. When the economy is overheating, bond yields will rise, which will slow the economy and squelch the threat of higher inflation. If the economy is weakening, yields will fall, and the economy picks up, safeguarding employment. Warsh alluded to this mechanism Wednesday: “Even while at some level we haven’t done much in 42 days, the markets have done quite a bit.”

But this only works if the Fed actually behaves as markets expect. Bond yields rise because they are pricing in higher short-term rates. If the Fed doesn’t deliver, that pricing will reverse.

Bond yields rose between the June and July meetings because of growing expectations that the Fed would raise interest rates. But the Fed didn’t deliver. As to why, Warsh declined to say.

When June’s benign inflation report was released, markets certainly saw that as a reason not to tighten. Yet Warsh said it was “not much” of a factor: “We are not relying on any one individual piece of data.”

So how are markets supposed to interpret inflation data in the future if they are told such an important release had no bearing on interest rates? (…)

• How Warsh Left Investors Baffled at His Second Press Conference

Kevin Warsh’s second press conference as Federal Reserve chairman puzzled economists and investors, who appear unconvinced the new central bank chief is as committed to stamping out inflation as he says.

Warsh, who has said he won’t share his view of when or whether the Fed might adjust interest rates, went further on Wednesday and refused to explain how policymakers might react to different economic outcomes. He praised a run-up in bond yields since the Fed’s last meeting, arguing it was helping the central bank and could mean officials don’t need to raise rates to bring down inflation.

Investors responded by dumping 30-year Treasury bonds and dialed back expectations for rate hikes over the coming months. (…)

He’s been adamant about not issuing “forward guidance,” or an indication of what the Fed might do in the future, and yesterday he argued it’s working. While Warsh isn’t speaking much about what he thinks Fed policy should do, other Fed officials still are. Some analysts said the Fed chief’s characterization of what’s going on in markets isn’t right — investors are listening to his colleagues, trying to forecast what the Fed might do, then pricing that in. (…)

he seemed to acknowledge interest rates are only one part of the Fed’s arsenal. Taken with the comments he made about higher bond yields helping policymakers do their job, Warsh seemed to suggest the Fed might not need to increase rates to bring down inflation.

The Fed has other policy tools — including its balance sheet — and financial markets do influence the broader economy, but the central bank has primarily relied on adjustments to interest rates to control inflation or bolster the labor market. Warsh’s comment left Fed watchers wondering how, exactly, he would deliver stable prices without raising rates. (…)

Circularity is the word of the year!

Trump’s Tariffs Are Sending Some Companies Back to China For some U.S. brands seeking a location for their factories, the economic logic is once again pointing to China.

(…) When President Trump’s tariffs on China hit 145 percent last year, companies embarked on a panicked search for cheaper alternatives in countries like Vietnam and Thailand, including this facility.

But since then, U.S. tariffs on China have come down sharply, leaving the leaders of some of those same companies with second thoughts. (…)

One of the most surprising outcomes from a whiplash year of tariffs may be that China has emerged in a position of relative strength, with significantly lower tariffs than last year. The Trump administration last week imposed a new tariff rate on Chinese exports of 12.5 percent, similar to rates for dozens of other countries, as it works to resurrect the tariffs struck down in February by the Supreme Court.

Chinese exports are still subject to other duties, including from Mr. Trump’s first term, and more tariffs could be on the way. But many industry executives and analysts speculate that the Trump administration will keep future tariffs on China relatively restrained to try to stabilize a rocky relationship.

The overall U.S. weighted tariff rate on Chinese goods is slightly above 23 percent, according to an analysis by Guojin Securities, a Chinese financial firm. And for some products, the tariff rate for China is identical to the rate on exports from Southeast Asian countries, where many companies have moved their supply chains.

(…) making flashlights in Thailand costs as much as 15 percent more than it does in China, as a result of higher costs for materials and transport. Mr. Laster is also under pressure from Chinese competitors that are selling flashlights on Amazon for less than it costs ACG to ship its products to the United States.

“We don’t want to go back to China, but at the same time, we’ve got a business to run,” he said. (…)

“China keeps doing really well because they just have the scale to produce things that much cheaper,” said Deborah Elms, who is head of trade policy at the Hinrich Foundation in Singapore. (…)

North American brands have shifted more of their sourcing back to China in recent months as fuel shortages from the war with Iran further strained factories in countries like Vietnam, said Sebastien Breteau, the founder of Qima, which audits supply chains for thousands of companies, including Costco, Amazon and Ralph Lauren.

Amazon, Microsoft Results Show AI Spending Spree Remains Solid

Aggressive AI spending plans by Amazon.com Inc., Microsoft Corp. and Alphabet Inc. provided fresh evidence that demand for chips and related equipment will remain strong, offering relief to a sector that’s been battered in recent days.

Amazon boosted its forecast for full-year capital expenditures to $220 billion on Thursday, up from a previous estimate of $200 billion. And Chief Executive Officer Andy Jassy said most of that spending will go toward artificial intelligence. (…)

Microsoft affirmed its capital expenditure forecast, absent the impact of an accounting change. Google parent Alphabet raised its spending outlook, and Meta Platforms Inc. increased the low end of its guidance for capital expenditures.

That’s good news for the businesses that make chips, networking gear and other technology used in data centers. Fears of a potential spending slowdown had weighed on shares of those companies. (…)

Amazon investors applauded its results, which showed that cloud computing revenue accelerated for a fifth straight quarter. The message: The company’s spending spree is getting results.

Microsoft got a similarly warm reception. It added nearly half a trillion dollars to its valuation on Thursday after reporting the fastest cloud growth in four years. The $450 billion increase to its market capitalization was the biggest single bump for any company in history.

Investors were less impressed with Meta and Alphabet. In both cases, the companies were dogged by concerns that their expenditures didn’t have a clear payoff. (…)

In any case, all that spending is poised to benefit suppliers that had been under a cloud recently. (…)

Several of these companies were among the public holdings of Leopold Aschenbrenner’s hedge fund, Situational Awareness, which sold off some of its equity positions after suffering losses in the AI stock rout in recent weeks, according to people familiar with the matter. That may have accounted for some of the stock declines. (…)

Apple Slides After Supply Shortages Hurt Sales Forecast

(…) Apple has been struggling to secure enough computer processors and counter fast-rising memory costs, a situation that forced the company to raise prices on Macs and iPads last month.

The supply crunch has also led to extended wait times on key computers like the Mac mini and Mac Studio. On the call, Chief Executive Officer Tim Cook said constraints would affect more Macs, iPhones and iPads in the current quarter. Currency fluctuations are hampering growth as well.

The disappointing forecast sent Apple shares down about 7% in premarket trading on Friday. (…)

If Apple is impacted by shortages, imagine smaller players.

BTW, Apple has borrowed from car manufacturers’ playbook to help customers fight inflation:

The company is also making some changes to how it offers products. On Tuesday, it rolled out a device leasing program called Apple Upgrade, allowing users to essentially subscribe to iPhones, iPads and Macs and trade them in at the end of their lease terms. The program, which resembles car leasing, will likely mitigate the recent price increases for many buyers.

Corporate insiders are sending warning signals about the stock market Corporate insiders haven’t been this bearish in more than 20 years

(…) Consider the measure of insider sentiment favored by Nejat Seyhun, a finance professor at the University of Michigan and a leading expert on interpreting insider behavior. This measure is the number of companies with net buying from corporate officers and directors, expressed as a percentage of all companies that had any buying or selling from those insiders. (…)

Seyhun has found from his research that insider selling is an especially bearish signal when it comes in a declining stock market. When that happens, it usually means that insiders on balance are not confident that the market will recover quickly enough to make waiting to sell worth their while. (…)

Insider sentiment has been trending lower for several years now, as you can see from the accompanying chart. The Seyhuns’ insider-sentiment measure has been below average for a large majority of months during the last three years.

To be sure, the stock market has been remarkably resilient over these three years in the face of above-average insider selling. So at a minimum, the insiders’ caution has been premature. It nevertheless seems a good bet that, sooner or later and quite likely sooner, the market will succumb to the gravitational pull of insider bearishness.

From Gurufocus:

As of July 2026, the current Overall Market Insider Buy/Sell ratio is 0.23. The previous monthly ratio was 0.27. This means insiders’ buying activity is lower, indicating they may be less optimistic about the market than last month.

For the past 5 years, the highest Overall Market Insider Buy/Sell ratio was 0.81 in May 2022, while the lowest ratio was 0.17 in February 2023. The average Insider Buy/Sell ratio is 0.35.

Compared to the past 5 years, the current Insider Buy/Sell ratio of 0.23 is lower than the 5-year average, meaning insiders are less actively buying and might be less optimistic about the market.

INK Research:

Insider trading windows are starting to open as companies report Q2 earnings, and we see that the level of absolute dollar insider selling has picked up and is now above average for a typical 60-day period. Last week, our INK US Indicator was at 25.4%. In the time since, it has dipped under the 25% mark and was at 24.1% as of Tuesday.

At 25%, there are four stocks with key insider selling for every one stock with key insider buying over the past 60 days. That is the lowest the indicator has been in a year, and it is notably lower now than it was during the market sell-off in the opening months of the Iran War. Moreover, our shorter-term 30-day indicator is also weakening. It was at 18.4% a week ago and has now fallen to 15.6%.

At the sector level, Industrials, Consumer Discretionary, and Consumer Staples sentiment have continued to weaken. As we noted last week, we had Consumer Staples, the last remaining sector without an overvalued reading, on watch for a potential downgrade to overvalued. We are now downgrading it.

Solar to Soon Pass Coal as China’s Top Power Capacity Source

(…) Total installed generating capacity is expected to reach 4,300 gigawatts by the end of 2026, with solar and wind accounting for about half of the total, the council said in its latest power industry forecast. The share of thermal power is projected to fall further to 31%. (…)

FYI:

Data: Silver Bulletin. Chart: Noah Bressner/Axios

Yesterday:

The defense minister himself, Prince Khalid bin Salman, went to the White House and asked U.S. President Donald Trump and Vice President J.D. Vance to wind the war down.

In Washington, the Saudis said they did not intend the strikes in Iraq as a move toward a bigger war, and they would rather the Americans talked to the Iranians than bombed them. Israel’s Prime Minister Benjamin Netanyahu was in the same building this week arguing it the other way. The Saudis have also opened their own channel to Yemen’s Houthis—the militia that was attacking their tankers in the Red Sea last week—while asking the Americans to stay out of it.

To be continued…