As 2026 has developed we have seen bond yields become a bigger and bigger issue. As I type this the situation is accentuated by depending on your position either hopes or fears over what Federal Reserve Chair Kevin Warsh will say this afternoon UK time. We can learn something from this from Nick Timiraos of the Wall Street Journal.
The Fed is divided over whether policy is tight enough and now comes a new complication: what if Bessent’s push on bond yields works? Lower long-term yields would ease financial conditions right as the Fed may not want that. Debt management has always been Treasury’s job. Using policy to shape the level of long-term rates and broader credit conditions has been the Fed’s. A policy shift is “a real pain for Warsh,” says one former Fed adviser. “Doing it now, just before Jackson Hole, strikes me as pretty inconsiderate if not a slap in the face.”
For those unaware Nick was the journalistic mouth for former Federal Reserve Chair Jerome Powell so I think we know the real source of this. He may be enjoying it a little too much. The Financial Times has posted an opinion piece which gets near the issue.
Warsh has repeatedly made verbal commitments to central bank independence and a 2 per cent inflation rate, but these commitments mean little without details of how they will be achieved.
Then rather drifts away.
Hesitancy to provide more insight into his thinking has created an uncertainty premium that affects the financing of everything from home mortgages to emerging market sovereign debt. Investors will hope his speech can begin to reduce that uncertainty.
Personally I think that his thinking is all too plain as he has failed to do anything about this.
Inflation is running persistently above the central bank’s 2 per cent target.
He has had the opportunity to raise interest-rates in response but has failed to do so. As the appointee of a President who wants much lower interest-rates he has looked like someone who might talk the talk on inflation but will not act. I find it hard to see how he can fix that this afternoon.
Never believe anything until it is officially denied
That phrase came to mind as I read this from Stephen Miran in the Financial Times.
Contrary to the assertions of some commentators, the recent rise in interest rates on long-dated US Treasuries is not indicative of financial markets starting to question the soundness of US debt, nor of credibility problems at the Federal Reserve.
In case you were wondering he is described like this and the latter part is especially relevant in my opinion.
The writer is senior strategist at Hudson Bay Capital and former chairman of the Council of Economic Advisers and was a member of the Federal Reserve Board of Governors.
You might reasonably think that after the absolite debacle that official claims about measures of inflation expectations became in the cost of living crisis that they would be shelved for good. But apparently not.
The most reliable metric of inflation expectations comes from the inflation swaps market, which has been extremely well behaved; inflation expectations are consistent with the Fed’s 2 per cent target at every tenor and across the forward curve.
As I pointed out back then you can expect whatever you like but as you continue to fail to hit your target as the Federal Reserve has people start thinking for themselves. Indeed at the extreme the argument below could be used even if you never hit the inflation target.
It’s therefore inappropriate to say the increase in yields has anything to do with central bank credibility — that rests entirely on expectations that it will achieve its inflation target, which markets show absolutely no sign of doubting.
Indeed as we have finite lifespans you could argue that we have a de facto equivalent of never at the moment.
For context, the inflation rate has remained above the Fed’s 2 percent target since 2021, based on the Fed’s preferred inflation measure, the personal consumption expenditures price index. The FOMC set the Fed funds target range at 3-1/2 to 3-3/4 percent at the March FOMC meeting.
That was from the Atlanta Fed in April and we remain above target with the same interest-rate.
So if the things we have looked at are not the reason what is?
With term premium and inflation expectations contained, the recent increase in bond yields is therefore almost entirely due to higher expected overnight rates over the long term. In other words, investors are marking up their expectations for long-run economic growth, not becoming concerned over central bank or fiscal credibility.
This is rather awkward on two counts. The first and I realise this is outside the experience of younger readers. But in response to a situation of accelerating economic growth and inflation persistently above target central banks used to call in overheating and would raise interest-rates. So the opposite of what we might call the Trumpian message.
Also we are in territory which has caused trouble for Fed Chair Kevin Warsh.
Productivity growth and capital investment are strong.
This was in both his policy announcements so far. They created a debate which was added to by this earlier this month.
Nonfarm business sector labor productivity increased 1.4 percent in the second quarter of 2026, the
U.S. Bureau of Labor Statistics reported today, as output increased 1.7 percent and hours worked
increased 0.3 percent. (All quarterly percent changes in this release are seasonally adjusted annualized
rates.)
So a bit over 0.3% as we would record it which is a slowing rather than a boom. Now the Atlanta Fed continues to suggest a strong number for GDP growth of around 1.1% as we would record it for this quarter, so around 0.4% lower than the number I looked at on the 4th of this month, but still strong. However even with that it is not clear to me that 2026 is living up to the billing that Stephen Miran is giving it.
The market could be recognising that AI, deregulation and better tax policy are turbocharging the American economy.
Also for some time now deficit reduction has been just around the corner on a straight road.
With deficit reduction around the corner due to tariffs, growth and disinflation,
Also let me be clear that the statement below is really rather stupid.
Shorter-maturity debt issuance is the orthodox response to temporarily wider deficits and that response is a key part of regular and predictable debt management.
Comment
This has been a phase where there have been two clear issues. One is fiscal expansionism and another is persistent inflation. They are why bond yields have risen. Next is the issue of growth where there is more of a nuance. US economic growth may not match the claims of Mr. Miran but is internationally good. However contrary to his analysis below the problem is that it encourages even more spending.
A useful rule of thumb is that one percentage point faster economic growth will reduce deficits by about a percentage point of GDP, because revenues grow faster than outlays and interest payments in a booming economy.
Also we are back to overheating which as I have pointed out several times would in the past have led to higher interest-rates which as Chair Warsh as not done he has a problem later today which is hard to fix.
If we look at other markets we get some help bit some confusion. Help comes from the rise in Gold that we saw. Somewhere in there was a response to persistent inflation. More awkward are equity markets which should be affected by higher bond yields bit so far have kept hitting new all-time highs. All I can offer there is that an past colleague described it as climbing a wall of worry. Also all this has pretty much passed China and Switzerland by.