The economy is getting more expensive without getting weaker

The strangest thing happening in the U.S. economy right now is that the economy is getting hotter and more expensive at the same time.

September business activity just hit its highest level since July 2021.

The S&P Global composite PMI jumped from 56.0 to 58.4. New orders surged. S&P said the reading was consistent with roughly 5% annualized economic growth.

But the same report found backlogs rising, supply-chain delays increasing and prices being pushed higher by capacity constraints.

That creates a nasty problem for the Federal Reserve.

The economy isn’t giving policymakers an obvious reason to ease.

Inflation is still above target.

Oil is feeding into costs.

Demand is still running hot.

And the Fed has already lifted its policy rate to 3.75%–4.00%.

Now look at what is happening beyond the overnight rate.

The 10-year Treasury yield crossed 5%.

The 30-year mortgage jumped to 7.12%, the highest since May 2024.

This is where the story changes.

A 7% mortgage doesn’t merely make housing “less affordable.”

It changes behavior.

Purchase mortgage applications are down 11% from a year ago.

Refinancing applications are down 62%.

Refinancing has fallen to its slowest pace since February 2025.

And borrowers are moving toward adjustable-rate mortgages. ARMs now represent 9.8% of mortgage applications, because 5/1 ARM rates were more than a percentage point below the 30-year fixed rate.

That is a financial system adapting to expensive money in real time.

People aren’t necessarily walking away from housing.

They’re changing how they participate in it.

Some don’t move.

Some don’t refinance.

Some delay buying.

Some take more interest-rate risk.

That means the housing market can become increasingly dysfunctional without producing the kind of spectacular collapse that gets everyone’s attention.

There is another clue sitting in plain sight.

McDonald’s now expects industry traffic in its key markets to remain flat while inflation stays elevated.

Think about what that means.

McDonald’s is one of the places consumers go when they’re supposed to be trading down from more expensive restaurants.

Yet even McDonald’s is saying inflation is constraining traffic.

The company is responding with an $8.5 billion franchisee support program through 2036, including about $5 billion through 2030.

It wants roughly 250 basis points of restaurant-level efficiency gains, worth about $100,000 in annual cash-flow benefits for the average U.S. restaurant.

It is targeting operating margins in the low-to-mid 50% range by 2030.

That tells you where corporate America is moving.

When customers won’t tolerate endless price increases, companies have to find another way to protect economics.

McDonald’s wants more demand and more efficiency.

That is a subtle but important change.

The inflation era initially allowed companies to raise prices and see how much customers would tolerate.

Now consumers are pushing back.

The response is discounting, smaller portions, value menus, automation, technology, productivity and tighter cost control.

The price increases don’t have to stop completely.

They just can’t carry the entire burden anymore.

And this is happening while demand is still strong.

That’s the part that makes the current environment unusual.

The consumer isn’t necessarily collapsing.

The consumer is becoming selective.

The housing buyer isn’t necessarily gone.

The buyer is waiting.

The homeowner isn’t necessarily selling.

The homeowner is sitting on a cheap mortgage.

The restaurant customer isn’t necessarily disappearing.

The customer is looking harder at the bill.

That creates a low-turnover economy.

Less refinancing.

Less housing turnover.

Fewer large purchases.

More waiting.

More trading down.

More sensitivity to financing costs.

And more competition between companies for the same consumer dollar.

Now add the government bond market.

CBO’s dynamic estimate of the 2025 reconciliation law found that the legislation would increase 10-year Treasury rates by an average 14 basis points over the 2025–2034 period.

CBO also estimated that the law would increase deficits by roughly $2.8 trillion over that period under its dynamic estimate, before separately accounting for additional debt-service effects that brought the estimated increase to about $3.4 trillion.

The broader CBO budget outlook has federal deficits reaching $1.9 trillion in 2026 and $3.1 trillion by 2036, with net interest costs driving much of the increase.

That matters because the cost of money is now interacting with the cost of government borrowing.

The Treasury has to issue debt.

Companies need capital.

AI infrastructure is consuming enormous amounts of capital.

Consumers need mortgages and credit.

And investors can now demand around 5% from a 10-year Treasury.

Money has alternatives again.

That changes the hurdle rate for everything else.

A company doesn’t have to issue debt at 3% anymore.

A homeowner doesn’t get a 3% mortgage simply because inflation eventually falls.

A stock doesn’t automatically become attractive because the Fed cuts the overnight rate.

The long end of the market has its own problems to solve.

And that’s why the 10-year yield matters more than another headline about what the Fed might do next month.

The Fed can control the short end.

It cannot force the entire financial system back into the zero-rate world.

That distinction is becoming visible in housing.

It is becoming visible in corporate capital spending.

It is becoming visible in consumer behavior.

And now McDonald’s is basically putting it in an earnings presentation.

The U.S. economy can keep growing while the cost of participating in it keeps rising.

That may be the next phase of this cycle.

Not a sudden recession.

Not runaway inflation.

Something more awkward:

an economy that remains productive enough to keep growing, but expensive enough that households and companies increasingly have to optimize every dollar.

That is why a 5% Treasury yield and a 7.12% mortgage can matter even when GDP isn’t collapsing.

The economy doesn’t have to break.

It can simply become harder to operate.

And once people start adapting to expensive money, getting back to cheap money may not be as simple as waiting for one Fed rate cut.