What if the Bond Market Isn’t Warning About Inflation

The common theory being propagated by the media is that because CPI and PPI came in hot last week, the new Federal Reserve Chairman Kevin Warsh has to do something about inflation. The headlines have been screaming this across financial media for days now:

The CNBC article is particularly interesting as it quotes one of the permabulls, Ed Yardeni of Yardeni Research where he states:

Yardeni’s evidence: The 2-year U.S. Treasury yield is above the federal funds rate, or FFR. When this happens, investors are hinting that they do not believe the FFR is high enough to bat down inflation, he said.

“The market is signaling that the current FFR is too low to curb inflation and may have to be hiked,” Yardeni wrote in a Wednesday note to clients.

The chart CNBC provided for this is illustrative of how the media shapes the narrative. The portion circled in red is what Mr. Yardeni is talking about.

The problem with using a short term analysis is one gets a distorted result. The Fed has only been tracking the FFR versus the US 2 year since the GFC. When one stretches the chart out to those fun times, it does provide a different perspective.

In 2009 the 2 year stayed persistently above the FFR as investors were more worried about the return of principle rather than political-economy of the games being played by Bernanke and Obama to re-stimulate the financial system.

If one looks at the spike in November of 2018, the 2 year had spiked to almost 3% but as rumors and stories of institutions having liquidity problems hit the street, the flight to safety had driven the 2 year down to 2.55% by Christmas Eve; the shortened trading day which resulted in the Powell Put becoming established to bail out foolish Wall Street behavior.

Meanwhile, the inflation threat was huge back in the day and in fact after the 2018 Christmas bailout, there was a spike in inflation which ended with Covidmania in 2020.

This brings the old argument back of “is 3% the new 2%” floor for the Federal Reserve policy makers.

But what of this theory that “investors” are sweating inflation now? Inflation has indeed spiked but the data is rearward looking and for some strange reason nobody in Wall Street media, or the Fed for that matter, wants to gamble on what the post-Iran war era looks like.

The selling of US bonds could simply be the impacts of China and Japan rolling long term bonds off their books and moving into short term instruments. It could also be providing a hint as what the future may indeed be telling us if one goes beyond the traditional sovereigns.

Logically, large institutions would be moving more of their allocations into TIPS (Treasury Inflation Protected Securities) as a hedge if the inflation threat was perceived as real. So what has been the reaction thus far?

Let’s take the long view from the iShares TIPS Bond ETF:

So far the price is holding in a lower range below the breakout level of 120 and no indication that a severe bout of long term inflation is on the horizon.

Let’s check one more chart and begin to draw some conclusions as to possible market risks or outcomes.

Bond volatility as measured via the Bank of America MOVE index on the ICE is still below historical levels of panic. The March spike above 115 primarily due to the instability from the war should be considered a proverbial line in the sand if one carries this through the history of this index. A violation of this number might well indicate widespread selling of US government bonds, especially in the 5 year and longer part of the duration curve.

Risks and Conclusions

When one is wrong or partially incorrect, I do believe in admitting it and the forecast I made in December of 2025 is somewhat hotter than I ever imagined:

4.After an inflationary scare in the first quarter of 2026, disinflation then outright deflation becomes the theme of the year. The 2 year yield gets no higher than 3.75% and ends 2026 closer to 2.50%. 10 year yields initially spike over 4.30% only to finish 2026 around 3.50%. 10/3’s finally blow out above 100 bps spread causing many economists to scream the recession is here.

I blew the forecast on the 2 year yield not even imagining the Fed nor Trump administration would allow markets to carry this above a 4% yield, but here we are. On the flip side, the 10 year is now well above the 4.30% level I forecast and looks intent on making a run for 5% before it rolls over. I stand by my forecast of the 10/3’s spread blowing past the 100 bps level.

But what about the rest?

I think that Fed Chair Warsh will come out with a very hawkish hold during the June 16-17th meeting as that hopefully will be the time period during the last two weeks of the month where Trump demands the war with Iran gets wrapped up. The inference of a “hawkish” FOMC threatening to raise rates should be enough to intimidate the bond vigilantes temporarily. The bigger threat of disinflation due to demand destruction due to tariffs and the war, followed by a period of outright deflation should become more apparent later in the summer.

Again, regardless of what the speeches from the Fed’s talking heads proclaim for the next two or three weeks, it is this author’s belief that if the Federal Reserve will issue a statement similar to June 28, 2007 where they stated:

In these circumstances, the Committee’s predominant policy concern remains the risk that inflation will fail to moderate as expected.

Warsh will walk the tightrope without realizing Fed policy has been impaired by fiscal dominance and their ability to influence bond prices and economic policy using traditional tools from the past thirty years.

What is the real risk however?

There is an outlier risk which is possibly becoming part of the problem for long term US government debt. Besides the obvious insanity of having over $40 trillion in debt by the end of this year, the political instability being demonstrated by our nation is starting to scare people away from our shores. It’s nothing of huge volume yet, but in an era where financial fraud is rewarded, the rule of law arbitrarily enforced, and the political leadership of both parties demonstrating gross irresponsibility and instability, would any sane nation or entity want to gamble with one’s fortunes?

It’s terrifying enough for those of us who live in the U.S.

After all, it’s not about Main Street any longer, it’s about the next algo driven headline so the degenerate gamblers can profit from the greatest casino in history.