The Bond Market’s Inflation Warning

Good Morning Ladies and Gentlemen

“Thursday a week ago, Microsoft’s market capitalisation increased more than any company’s ever has in a single day. It jumped 16% to add $450 billion to its value — that alone is larger than 96% of the S&P 500 companies or the entire stock market of South Africa.”

Bloomberg Tech In Depth

Will the Federal Reserve Act?

The upcoming Federal Reserve meeting is scheduled for September 16, with a current likelihood of a key interest rate increase at 67%. In contrast, there is a 33% chance that the rate will remain unchanged. Analysts predict that another rate hike may occur in January 2027. The ongoing conflict in Iran, coupled with regular rises in energy prices, is contributing to heightened inflation expectations, further intensifying speculation around potential increases in key interest rates. Currently, the 5-year break-even inflation rate is at 2.26%, indicating a low range. Break-even inflation serves as a leading indicator for the U.S. inflation rate. According to its nowcast, the Cleveland Fed anticipates a July inflation rate of 3.4%, representing a slight decrease from June’s rate of 3.5%, both of which are lower than May’s figure of 4.2%. Nevertheless, the market generally expects the Fed to raise the key interest rate at its upcoming September meeting.

30-Year US Yield

Broadly speaking, the 30-year U.S. Treasury yield continues to trend higher, although recent trading has been characterised by heightened volatility. In late July, the yield surpassed 5.2%, marking its highest level since 2007, and reached approximately 5.22% on August 6, up from around 4.9% at the end of June. The rise in long-term yields reflects investor concerns about persistent inflation, elevated energy prices, and the likelihood that interest rates may remain higher for longer than previously anticipated. Long-term real yields are also exceptionally high, with the yield on 30-year Treasury Inflation-Protected Securities (TIPS) nearing levels only briefly observed during the 2008 financial crisis.

Midterm Elections

This is unlikely to please President Trump and his administration, who can do without higher interest rates so close to an election. Yet the bond market is continuously sending an increasingly clear signal that inflation risks remain elevated and that monetary policy may need to stay restrictive for longer. The key question is whether Federal Reserve Chair Kevin Warsh will once again resist market expectations or ultimately acknowledge the pressure building in long-term yields. With the 30-year Treasury yield at its highest level since 2007, investors are watching closely to see whether the Fed prioritises political sensitivities or its commitment to price stability and credibility.

Kevin Warsh and the Fed and the American President

However, it is not entirely certain that the Federal Reserve will raise the key interest rate on September 16. Even though Kevin Warsh has repeatedly expressed his intention to bring inflation back to 2%. It seems Warsh is aligning with President Trump’s political stance, which views interest rate increases as highly detrimental. Interestingly, a working group at the Bureau of Labour Statistics is presently examining how core PCE inflation (the Fed’s preferred measure) could be recalculated to lower its figure. Observers believe this adjustment could potentially reduce the rate by 0.2 percentage points.

Conclusion

The stark contrast between Microsoft’s record-setting surge in market value and the growing unease in the bond market underscores a defining tension in today’s investment landscape. The recent increase in long-term Treasury yields indicates that the inflation narrative is far from resolved. While headline inflation has eased, ongoing pressures from energy prices, geopolitical tensions, and resilient economic activity continue to raise concerns that price growth may remain above central bank targets for an extended period. The bond market is becoming increasingly sceptical that inflation will swiftly return to manageable levels, prompting demands for higher yields on long-dated government debt. With the 30-year Treasury yield reaching its highest point since 2007, investors should remain cautious about the risk of inflation proving more persistent than anticipated, potentially forcing policymakers to uphold restrictive monetary conditions well into 2027.

Ladies and Gentlemen

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I wish you an excellent start to the day and weekend!

Yours truly,

Stefan M. Kremeth
CEO & Head of Wealth Management
Incrementum AG – we love managing assets

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