Inflation accelerates

Inflation concerns moved back to the center of the market narrative this week after the April CPI report came in hotter than expected. Headline CPI rose 0.6% month-over-month and 3.8% year-over-year, up from 3.3% in March, while core CPI rose 0.4% on the month and 2.8% from a year ago. Energy was the biggest driver, rising 3.8% in April and 17.9% over the past year, while gasoline prices were up 28.4% year-over-year. Food prices rose 3.2% over the past year, and shelter remained sticky, reinforcing the concern that inflation is not confined to one isolated category. The report was a reminder that even after significant progress from the post-pandemic inflation peak, the path back to the Fed’s 2% target remains uneven and vulnerable to renewed commodity-price shocks.

• The continued closure of the Strait of Hormuz has meant elevated energy prices
• This is beginning to flow through to inflation measures
• This is particularly challenging for the Fed as the new Chair, Kevin Warsh, takes the helm
• The stock market has not traded on elevated inflation rates, as market participants expect energy prices to recede upon a formal end to the conflict in Iran
• However, the longer energy prices stay elevated, the more pressure it puts on the consumer, and hence the economy
• While recession is not a risk on anyone’s radar, the market may shift from the overwhelming focus on AI to inflation and economic weakness

Rates rise into dangerous territory

The bond market reacted sharply to the inflation data and broader concerns that higher oil prices could keep inflation elevated for longer. By Friday, the 2-year Treasury yield rose to 4.071%, the 10-year climbed to 4.568%, and the 30-year reached 5.112%, with the 10-year and 30-year both reaching their highest levels since May 2025. The move was not just about one CPI report; investors were also responding to higher oil prices, geopolitical risk around the Strait of Hormuz, and the possibility that the Fed may need to keep financial conditions tighter for longer. Higher long-term rates matter because they flow directly into mortgage rates, consumer borrowing costs, corporate debt costs, and equity valuations. The key takeaway is that the bond market is now doing some of the Fed’s work by tightening financial conditions on its own.

• The yield rise in the US was not in a vacuum; rates have spiked across the globe, including the UK and Japan
• The market has recently focused on 4.5% for the 10-year as a threshold that previously seemed to worry Treasury Secretary Bessent
• Last year, after the markets sold off following Liberation Day, the administration did not back down until the 10-year traded through 4.5%
• We will have to see if the same holds true for the conflict with Iran and if Trump’s administration backs down from its current posture

Market now pricing in rate hikes

Perhaps the most important change this week was not the level of inflation or Treasury yields, but the shift in what markets now expect the Fed to do next. Earlier this year, investors were still debating the timing and number of potential rate cuts, but futures markets have increasingly moved toward pricing the possibility that the Fed’s next meaningful move could be a hike instead. Reports this week showed traders assigning rising odds to a rate increase by late 2026 or early 2027, with one market snapshot showing a meaningful probability of hikes by December. That is a major change in tone: the Fed is no longer simply deciding when it can ease policy, but whether inflation pressures are strong enough to require renewed tightening. For investors, the practical implication is that the “Fed put” is much weaker when inflation is moving in the wrong direction.

• Kevin Warsh was confirmed as the new Chairman of the Fed by the Senate this week
• He steps into the role during a very difficult time
• Trump has continuously attacked his predecessor for not lowering interest rates more
• Presumably, Trump’s nomination of Kevin Warsh was with the goal of a Fed Chair more in line with his views
• However, if inflation continues to be persistently too high, and yields rise, it would be difficult for Kevin Warsh to cut rates in the near term
• In fact, the market is now pricing in almost 1 Fed hike by the end of the year
• At the beginning of 2026, the market was pricing in 2 cuts for the year

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