Bond yields are falling as inflation pops. The Fed's tough talk under Warsh is helping.

By Joy Wiltermuth

The big test might come in 2027

Kevin Warsh, the new Federal Reserve chair, is helping coax Treasury yields lower by talking tough on inflation.

The Federal Reserve under its new chair, Kevin Warsh, sounds serious about getting back to 2% inflation.

The guarded tone seems to be enough - for now - to ease nerves in the $30 trillion Treasury market. This comes despite inflation data for May showing the current rate is more than double the Fed's target.

"His tough talk helps," Steven Blitz, chief economist at GlobalData TS Lombard, said on Friday. Warsh signaled that he won't cut rates to please the White House or let inflation fly, which is helping pull Treasury yields lower, Blitz said. "That makes a big difference."

The Fed's preferred inflation gauge reached 4.1% on Thursday, the highest reading since April 2023. That's in the same ballpark as the reading of the consumer-price index two weeks ago.

The rates market took some solace in that reading not coming in any worse than feared, said Garrett Melson, portfolio strategist with Natixis Investment Managers Solutions. With oil prices back near where they were before the start of the Iran war, there's optimism that inflation may be peaking, he said.

U.S. and global oil (CL00) (BRN00) prices were down close to $70 a barrel on Friday, despite an Iranian attack on a ship in the Strait of Hormuz that underscored the fragile nature of the cease-fire.

Related: A world rejecting OPEC controls could usher in oil below $50 a barrel

Since Warsh's first press conference as Fed chair in June, the odds of a rate hike in 2026 have climbed. He spoke of markets having a bigger voice in guiding the path of rates, inflation and the economy.

After all, 10-year Treasury yields BX:TMUBMUSD10Y have pushed higher, not lower, since the Fed started cutting short-term rates in September 2024, as the below chart shows.

The 10-year Treasury yield is important to households because it's a starting point for new 30-year mortgage loans. It also underpins financing for businesses and the economy. It dipped to 4.38% on Friday, its lowest since late May.

The Treasury Department has kept a lid on issuing longer-duration government bonds to control supply and costs as it borrows to fund the large U.S. deficit. It would be dangerous for the Fed or the Treasury Department to lose the confidence of the bond market.

Meanwhile, households have dramatically depleted their savings this year while continuing to spend. The bull market in stocks SPX has helped families who own assets, even as rising inflation has eroded wages.

Warsh's anti-inflation rhetoric took some of the inflation premium out of the bond market this week, according to Blitz. "He won the PR battle out of the gate," he said. That buys some time to let lower oil prices filter through inflation data in the coming months, he said, but it doesn't guarantee the fight is over.

The yield on the policy-sensitive 2-year Treasury note BX:TMUBMUSD02Y fell to 4.09% Friday. But that's still well above the Fed's 3.75% upper limit for its policy rate. A higher Treasury yield corresponds with the Fed's June "dot plot," which also pointed to hikes this year.

Notably, Warsh declined to offer his own dots, saying he is not a fan of telegraphing such guidance to the public. The White House this week signaled support for Warsh taking an independent approach to managing inflation and the economy, despite having repeatedly badgered Warsh's predecessor, Jerome Powell, to cut rates.

"I don't think Kevin Warsh wants to come in and within his first six months of leadership be responsible for a rate hike," said Brian Rehling, head of global fixed-income strategy at Wells Fargo Investment Institute. "But if he's truly committed to 2% [inflation] and the economy remains robust, he may be backed into a corner."

The Atlanta Fed's tracker on Friday put the probability of a rate hike at 67%, off recent highs but up from 31% two months ago. That reflects the probability of the central bank's policy range moving up by 25 basis points.

Just the threat of rate hikes might help keep a lid on yields through the end of this year. But a stronger economy, fed by the artificial-intelligence spending boom, and an uptick in inflation could require more than talk in 2027.

"By next year," Blitz said, "they're going to be hiking" unless the equity market crashes.

Stocks were higher Friday, but both the S&P 500 index and Nasdaq composite COMP were set for weekly losses, while the Dow DJIA was up 0.8%, according to FactSet.

Now read: First-quarter GDP gets big boost, but it's not really great news

-Joy Wiltermuth

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06-26-26 1339ET