It’s the Fed, Not Inflation, Driving 10-Year U.S. Yields Higher

By Victor Sperandeo with the Curmudgeon

Disclaimer: The opinions expressed herein, other than the Curmudgeon’s Comments at the end, are that of Victor Sperandeo.

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Introduction:

The recent rise in 10-year U.S. Treasury yields is NOT a clear inflation signal, but rather a market verdict on Fed chairman Kevin Warsh’s hawkish posture. In my view, the move higher in U.S. yields are being driven by the prospect of a Fed that is preparing to stay tighter for longer and possibly raise rates. It's not due to any lasting new surge in inflation. In particular, the perception that the Fed Funds rate will be increased to achieve the Fed's 2% CPI (or PCE) target rate.

The U.S. yield curve has adjusted to Warsh's comments, as he never spoke of HOW he would control inflation, but "punted" to a "Fed Task Force" to help him sell his ideas of lowering money supply growth by shrinking the Fed's balance sheet. He did not want to offend the other FOMC members, as they are all “Neo Keynesians” who believe in lowering DEMAND by raising rates, thereby avoiding anything that Milton Friedman or the Austrian School of Economics believe in.

Inflation is NOT the Problem:

Analysts and market strategists are often too quick to slap the “inflation” label on every backup in yields. Yet a real inflation scare should be showing up more broadly in firmer inflation expectations, stronger nominal economic growth with a more convincing increase in real economic momentum. That is not happening now! What stands out is a market repricing the Fed’s reaction function.

Warsh’s rhetoric has effectively told investors that the Fed may be willing to keep leaning on short term rates as its preferred "inflation control" weapon. That matters because the 10-year yield is not just a reading on inflation; it is also a reading on expected monetary policy, term premium, and the market’s confidence that the Fed will not overdo it.

That is why I think the current move in U.S. 10-year yields is being mischaracterized. Note and bond investors are not actually reacting to hotter inflation data caused by higher energy prices. They are pricing in the risk that the Fed will stay restrictive for too long which will force the economy to absorb unnecessary pain. Warsh may be pushing yields higher by changing expectations around policy persistence, even if the inflation data do not fully support that move.

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Proof Points:

The reason I know I am correct is the 10-year TIPS price is now at a new low for 2026 and hasn't been lower since January 2025. If CPI prices were going up, the TIPS price would not be at a yearly low. Also, the three lower-quality (junk) bond ETF’s I watch - LQD, HYG, and JNK began to break last week and are headed for the lows for the year. LQD is already there!

If the Fed raises rates now, it would be akin to "throwing gasoline on the fire" of a disinflationary economy which will become more obvious going forward.

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Victor’s Opinion: I believe the FED will RAISE the Fed Funds rate 25 bps to 3.75-4.00% at this week's meeting as the U.S. 2-year benchmark yield is the offer side of Fed Funds historically, and it closed Friday at 4.33%.

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“Demand Destruction” Revisited:

Americans are now buying food on credit, which is obvious and clear proof of "demand destruction," which we discussed in this Sperandeo/Curmudgeon blog post. Raising rates will cost all consumers more and will not do a thing to stop the price rises of inelastic essential products like gasoline and heating oil.

The Fed’s ideology that rising oil prices will cause inflation, rather than a temporary price hike due to a shortage (Strait of Hormuz closed due to U.S.-Iran war), is the Fed's excuse to change policies before the mid-term elections, which is 97 days after the FOMC meeting this week. Remember that people vote with their pocketbooks.

The FED is making an absurd mistake IF they raise rates, and my hope is the bond market learns what Ollie (from Laurel and Hardy) said, “Here is another nice mess you have gotten me into.”

Curmudgeon Comments:

The U.S. note and bond market is telling us that Warsh’s hawkish tilt matters more than the inflation story the headlines want you to believe. The irony is that the bond market is doing the Fed’s work for it. If policymakers keep interpreting every supply shock as a mandate for tighter money, they will eventually validate the economic slowdown they claim to be trying to avoid. That is how a policy error becomes self-fulfilling.

End Quote:

“ECONOMICS IS THE (subjective social) SCIENCE OF THE MEANS TO BE APPLIED FOR THE ATTAINMENT OF ENDS CHOSEN “… Ludwig Von Mises (1881–1973) was a famous Austrian- American economist, historian, and a leading figure of the Austrian School of Economics.

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Wishing you good health, success and good luck. Till next time…..

The Curmudgeon
ajwdct@gmail.com

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever-changing and arcane world of markets, economies, and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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