May 2026

US 10-year Treasury yields have climbed to 4.54%, the highest since May 2025, while 2-year yields have also surged back above 4%. Despite equities rallying for several consecutive weeks, the bond market continues to signal concerns over inflation and a deteriorating global economic outlook.

Long-bonds priced in higher inflation expectation and higher Treasury supply. Sticky services costs, resilient wages and fiscal stimulus have been keeping the inflation expectation elevated. On the supply side, US is financing structurally large deficits (interest costs, entitlements and elevated outlay from an ongoing Iran conflict). As a result, much longer-dated bonds are due for auctions. Many foreign buyers have remained on the sidelines in recent years as has the Federal Reserve since they halted the quantitative easing program in 2022. Also, the acceleration of the AI narrative is attracting global investment capital away from the safety of US Treasuries. As a result, 5% can be a floor not a ceiling for 30-year US Treasury bonds unless inflation softens materially or the deficit shrinks.

Fed officials cautioned that interest rates may need to stay on hold for an extended period of time. They also note that the ongoing conflict in Iran could create more persistent inflation pressures while simultaneously dampening the growth in the economy with increasing risk of stagflation. No longer the Fed is expected to cut rates this year with the terminal rates (the peak level of the benchmark interest rates before policymakers halt hikes or start cutting rates) stays at 3.0-3.25%.

Investors remained concerned that sustained higher energy costs could keep inflation high and potentially reignite inflation expectations, with secondary effects spilling over into other goods and services. Against this backdrop, US Treasury yields moved higher across the curve with the 2-year yield rose above 4%,10-year yield climbed past 4.5% and the 30-year yield held comfortably above 5%.

A bear steepening of the yield curve has not historically served as a reliable signal for equity sell-offs and on average, has been followed by positive equity performance. While short-term drawdowns can occur as markets adjust to a higher-rate environment, the broader uptrend often resumes. Elevated rates do not necessarily derail bull markets when economic growth remains robust. Despite rising yields, the equity rally is well-supported by strong global government spending (With the US, China, Germany, and Japan — together accounting for more than half of global GDP — still in fiscal expansion mode), resilient consumer demand (April retail sales up 0.5% month-over-month) and significant corporate investment in AI infrastructure (data center capital expenditure running at 2.5% of US GDP and still rising). Household and corporates and government are spending, continuing to underpin equity prices. While higher mortgage rates may weigh on consumer activity, they are unlikely to curtail government spending already approved by the Congress or ongoing AI-related corporates’ capital expenditure. 

 

April 2026

 

The key variable for policymakers has been long-term inflation expectation (if it is anchored or not) not the headline inflation. Headline inflation is the raw inflation figure measured by Consumer Price Index, which reflects the direct cost-of-living impact on households and it is often more volatile than core inflation. Headline inflation has been pushed higher by energy prices and as a result, short-term inflation gauges such as one-year inflation expectation, have risen but long-term inflation expectations have stayed relatively stable. This reflects temporary energy-related price pressures rather than a structural shift in inflation dynamics. As there is limited pass-through from higher oil prices to core inflation (which excludes volatile food and energy components), Fed may look past the current spike in
energy prices.

 

Financial conditions have tightened due to higher oil prices since the start of the Middle East conflict and combined with a stronger dollar, equity risk premium was pushed up having the same effect as rate hike. This tightening reduces the need for additional policy tightening from the Fed. As a result, this oil shock may not change the Fed’s easing trajectory in the second half of 2026 as growth moderates and inflation gradually cools down. If the central bank delivers two 25-basis-point cuts, the policy rate will be brought down to 3.0% to 3.25% range (from 3.5% to 3.75% range). However, as energy shocks feed into broader price-setting, there could be a sustained rise in long-term inflation expectation. In that case, Fed will be forced to keep the interest rate higher for longer or even consider a rate hike.  

 

Monetary tightening works on the demand side so a supply shock cannot be fixed with monetary policy. Rate hike can rather exacerbate the slowdown in the economic activity potentially leading to a recession or a stagflation. Every
recession since World War II, except for the Covid-19 pandemic, was preceded by a jump in oil prices. Rising oil prices, an unsustainable tech capex boom, high home prices and stresses in private credit are all contributing to the risk of recession.

 

A strong rebound in employment in the US suggests that US economy is relatively in a decent shape to weather the economic headwinds coming from the Middle East conflict. However, job creation remains concentrated in handful of
sectors and rising uncertainty can make employers more hesitant to accelerate their hiring plans. Federal Reserve seems to be comfortable with maintaining its current policy, with steady growth and resilient labor market suggesting
the expectation of near-term easing can be premature.

 

Kevin Warsh, Trump’s nominee for Fed Chair mentioned that he had made no commitments to cut interest rates and put an emphasis on the central bank’s independence and shrinking Fed’s balance sheet. Prolonged disruption in the
energy market can force the Fed into monetary policy tightening. The Fed kept its policy rate at 3.5% – 3.75% in its April meeting as widely expected and focused on inflationary effect of the Iran conflict.