Reading Kevin Warsh's First International Appearance
Kevin Warsh's speech and panel appearance in Portugal at the European Central Bank's forum was notably restrained — he offered less concrete direction than many had anticipated. The tone of the panel itself was light: Christine Lagarde opened it by explicitly declining to commit to forward guidance, prompting Warsh to quip, "I like you even more now." The banter between the participants gave the session an unusually informal feel.
Beneath the levity, the substantive takeaways were clear. Warsh acknowledged that some price risks have receded over the last several weeks, citing that inflation expectations had gained a bit. Yet he coupled that acknowledgment with a firm restatement of his vow to bring inflation back to the 2% target. In other words, he conceded that certain risks have come down without stepping away from the hawkish stance established at the most recent FOMC meeting. The posture remains firmly hawkish even as he grants that the near-term picture has softened at the margins.
The AI-Inflation Question
Warsh was directly asked about AI's effect on inflation and declined to render a judgment on it. This is a delicate spot for him, because he has previously been quite explicit in arguing that AI innovation will largely be deflationary. The difficulty is that real-world price behavior is beginning to cut against that thesis: companies like Apple are raising prices in the face of rising memory costs, and Microsoft has moved to raise prices as well.
The likely conclusion is that Warsh will have to change his tune unless these price increases prove to be very short-term blips — and the evidence does not suggest they are. The transmission of AI through inflation channels feeds directly into core inflation. Several forces are compounding here: AI-related demand, memory costs, chip costs, and software costs are all pushing upward. This is now showing up through consumer channels, not just producer inputs, as the recent price hikes from Apple and Microsoft demonstrate.
Working in the opposite direction is the decline in oil prices, but that benefit accrues to headline inflation rather than core. The broader view is that even if you get an end to the war — whatever form that resolution takes and however sustainable it proves — and even with sustainably lower oil prices, that would not mark the end of the inflation story. The core, AI-fed pressures remain regardless of what happens to energy prices.
The Morning's Macro Data
The economic data released that morning painted a broadly constructive but nuanced picture. The ADP employment reading came in at 98K on the headline and, importantly, showed continued broadening — an encouraging signal about the breadth of hiring. The ISM manufacturing PMI printed at 53, keeping it in expansion territory, and its prices-paid component came down by almost 10%, which offered a measure of relief on the inflation front.
The market reaction was telling: yields ticked up across the curve, the dollar strengthened, and the Russell rallied. The aggregate data, however, does not do anything to move the economy out of what looks like an inflationary-boom backdrop. While the decline in the ISM prices-paid component was genuinely welcome, there were softer signals embedded in the release worth watching. The headline reading showed a slight downtick, and new orders also ticked down. These bear watching because manufacturing has just completed a six-month move back into expansion territory at the same time that the services side has rolled over a little. Still, it is far too soon to conclude that manufacturing is already rolling back over, and the outlook for the manufacturing side of the economy remains fairly optimistic.
Mid-Year Outlook: A Rotational Market
The first half of the year delivered remarkable performance across the board. It was the best half for the S&P and Nasdaq since 2020 — and on one measure the best in 60 years — the Dow's best first half in five years, the Sox's (semiconductor index) best quarter ever, and the Russell's best first half since the 1990s.
The base case is for this strength to continue into the second half, but the single most relevant theme for investors is likely to remain the rotational nature of the market. The rotations are rapid-fire and occur at every level of granularity — across sectors, across industries, and even down to the sub-industry level. A vivid example is communication services: the sector was down 8% in the month of June, then up more than 2% in a single day. Notably, the Russell has done extraordinarily well this year, crushing the S&P, and even the S&P small-cap index — a higher-quality small-cap benchmark — has performed much better.
Dispersion is widening even within very narrow cohorts. A useful illustration is what can be called the "neural nine" (or "narrow nine") — the Magnificent Seven plus Micron and Broadcom — where a big dispersion has opened up among these handful of names. This dispersion argues in favor of active management and stock picking. Even so, from a trading standpoint it remains a pretty tricky environment, which is precisely why diversification is so important right now.
