Inflation won’t die. Now the bond market is daring the Fed to do something about it

Supply shocks have become a familiar occurrence over the past six years, causing inflation to persist. Diane Swonk, KPMG's chief economist, compared the repeated shocks to a drumbeat, saying that households and businesses have learned to anticipate the next price increase. However, the bond market appears to be challenging the Federal Reserve (Fed) to take action against inflation.

The 10-year Treasury yield reached 4.92% on Thursday, nearing the 5% threshold that Wall Street has warned about. Despite Fed Chair Kevin Warsh urging caution, the bond market is reacting proactively, anticipating a rate hike. Swonk fears that this premature tightening will worsen the situation, as investors demand higher premiums if they doubt the Fed's ability to control inflation.

The latest producer-price report showed a 5.4% increase in inflation from a year ago, driven by soaring energy costs and rising prices for goods like eggs. However, some economists believe the report may already be outdated, and the impact on inflation may be less severe than expected. Fed Governor Warsh has hinted at a potential hike, but has been vague about the threshold.

If the Fed decides to rely on the bond market to address inflation, it could face risks, as investors may push the Treasury market to its limits, potentially shifting pressure onto the dollar.