Bond traders are sending incoming Fed Chair Kevin Warsh a welcome aboard message that puts a bit of a kibosh on his plan — which reflects President Donald Trump’s persistent demands — to lower interest rates.
Sure, the stock market has been racing to new exuberant highs even while the Iraq war is pushing oil, gas, and diesel prices to wallet-busting levels.
As I’ve reported, bond traders, however, have been preparing for inflation risks since the war began in late February.
And that preparation includes the possibility that the central bank will need to raise interest rates sooner than anyone, especially Warsh, expected.
The CME Group FedWatch Tool raised the probability of a quarter-point rate hike this year to 50% on May 15, up from the previous day’s odds of 40%.
The 30-year Treasury yield topped the 5% threshold this week, MarketWatch noted, and the benchmark 10-year yield hit the 4.5% mark May 15 for the first time since June 2025. The two-year yield rose above 4% for the first time in 11 months.
“Risk sentiment is being dented by a global rise in bond yields, driven by a combination of inflation concerns, expectations for central-bank hikes, and worries around government debt as countries look to cushion the impact of higher energy prices,” Angelo Kourkafas, senior global investment strategist at Edward Jones, told Bloomberg.
Inflation data spooks bond traders
Since the Iran war began, American consumers, especially those with lower or fixed incomes, have seen high gasoline and utility prices strain their household budgets. Meanwhile, businesses juggle the energy shocks by passing some of the cost of goods and services onto their customers.
The Bureau of Labor Statistics said the April Producer Price Index jumped 6%, the biggest year-over-year increase since 2022.
The April Consumer Price Index also came in hot May 13, jumping to 3.8% on a year-over-year basis, outstripping workers’ earnings for the first time in three years and marking the highest inflation print since the post-pandemic recovery in May 2023.
- The headline CPI climbed 0.6% from March, while the core gauge excluding food and energy costs rose 0.4%.
- Energy prices soared 17.9% year over year, with gas prices up 28.4% and fuel oil prices up a whopping 54.3%.
The Bureau of Economic Analysis released the March 2026 Personal Consumption Expenditures — the Fed’s preferred inflation gauge — on April 30, showing an acceleration in headline inflation largely driven by energy costs.
- Headline PCE (year over year): 3.5%, up from 2.8% in February
- Core PCE (year over year): 3.2%, (excluding food and energy) up from 2.9% in February
Despite rising energy costs fueled by the Iran war, U.S. employers added more jobs than expected for a second month, and the unemployment rate held steady in April at 4.3%, the Bureau of Labor Statistics reported.
Fed’s mandate requires a tricky balance
The Fed’s dual mandate from Congress requires maximum employment and stable prices.
- Lower interest rates support hiring but can fuel inflation. This risks fueling further inflation, potentially leading to an inflationary spiral.
- Higher rates cool prices but can weaken the job market. This increases the cost of borrowing and further stifles economic activity.
When will inflation settle down?
Tony Welch, chief investment officer at SignatureFD, told TheStreet in an email that the inflation narrativehas clearly shifted.
“What was once a tailwind for markets has become, at best, a neutral factor and, at worst, an emerging headwind,’’ Welch said. “Our key question is whether inflation settles back down as energy markets normalize or begins to spread more broadly through wages and consumer behavior.”
Related: Fed drops rate-cut bombshell
The Federal Open Market Committee held the benchmark Federal Funds Rate steady at 3.50% to 3.75% during its April 30 meeting. Several regional Fed bank presidents have raised awareness of possible rate hikes.
Warsh will preside as chair at the next FOMC meeting on June 18-19. His challenge will be deciding whether to push through a rate cut or continue the pause.
Bond yields becoming “a bit unhinged“
Economist Ed Yardeni, president of Yardeni Research, said in a note that bond market investors believe the Fed needs to play catch-up on inflation as Warsh takes over, CNBC reported.
Bond traders are hoping that policymakers display a slant toward tighter monetary policyat the June meeting, the economist said.
“The market is signaling that the current FFR is too low to curb inflation and may have to be hiked,” Yardeni wrote.
SocGen’s Subadra Rajappa said the Iran war’s energy spike will complicate Warsh’s ability to deliver the lower rates he has championed and that President Trump has demanded.
“I’m starting to get a bit concerned because bond yields definitely feel like they are getting a bit unhinged,” Rajappa told Bloomberg Television. “I think we should really be paying attention to the signals that we are getting out of the bond market.”
Bullish calls on stocks will be challenged if Treasury 10-year yields hit 5%, a level that usually depresses price-to-earnings ratios, Lori Calvasina at RBC Capital Markets told Bloomberg Television.
Related: BofA drops blunt warning about Fed rate cuts
