The consensus view holds that the Federal Reserve is on hold, waiting for clarity. What the Treasury market rate hikes now being priced across the yield curve suggest is something rather more uncomfortable: the bond market has stopped waiting and started demanding.
On Friday, the 2-year Treasury yield jumped 12 basis points to 4.17%, its highest level since February 2025. That earlier peak was reached on the way down, when the market was still anticipating rate cuts. The direction has now reversed. Since the end of February, the 2-year yield has risen by 79 basis points, shifting from pricing in cuts to pricing in multiple hikes. It now sits 54 basis points above the Effective Federal Funds Rate. That gap does not happen by accident.
The 3-year yield moved in lockstep, also up 12 basis points on Friday to 4.22%, the highest since February 2025 and up 81 basis points since the end of February. At 59 basis points above the EFFR, the message from the shorter end of the curve is consistent: the market is not merely anticipating a policy shift, it is applying pressure for one. As Wolf Street analyst Wolf Richter put it, the bond market can have ‘a powerful voice.’
The Labour Market Has Handed the Fed No Excuse
The immediate trigger on Friday was the jobs report. Three consecutive months of solid job growth, with upward revisions to the prior two months, and the three-month average at its highest since March 2024. According to Raymond James, job growth is averaging approximately 140,000 year to date, compared with only 10,000 last year. That is not the labour market of an economy teetering on the edge of a recession. It is the labour market of an economy that can withstand tighter monetary policy.
With the labour market data this firm, the Fed has little justification for keeping inflation lower on its priority list. Both the CPI and the PCE price index will likely show inflation above 4% in May, double the Fed’s stated target, and above that target for over five years by that point. According to CBS News, the PCE for April is expected to show inflation running at an annual rate of 3.9%, which would be the highest reading for the Fed’s preferred gauge since May 2023. Richter notes that inflation had been rising for months before the energy shock in March even hit, and has since spread beyond energy into other parts of the economy.
Treasury Market Rate Hikes Signal an Awkward Debut for the New Chair
Kevin Warsh steps into one of the more uncomfortable introductions in recent Fed history. His first FOMC meeting is scheduled for 16-17 June, according to Raymond James, and the yield curve is not offering him a friendly welcome. The 6-month Treasury yield, which broadly reflects bond market expectations for Fed rates over the next three to five months, rose to 3.80% on Friday, 18 basis points above the EFFR. That is consistent with the market pricing an initial rate hike later this year, not next.
The institutional backdrop adds another layer of complexity. Jerome Powell has remained at the Federal Reserve after his term as chairman ended, the first time that has happened in approximately 80 years, according to Raymond James. Whatever the internal dynamics of that arrangement, Warsh will need to build a majority on the Federal Open Market Committee in an environment where the bond market is already doing some of the arguing for him, whether he wants it to or not.
If the Fed were to claim it will ‘look through’ inflation running at twice its target, Richter argues the consequences would materialise in the long end. The 30-year Treasury yield crossed back above 5% on Friday after sitting just below that level for more than a week. It hit 5.19% on 19 May. The 10-year yield rose 8 basis points to 4.55%, a level Richter describes as ‘not high for this inflationary environment’ and possibly low, given that the bond market is still, if half-heartedly, accepting a story in which long-run inflation settles back toward 2.5%.
The arithmetic of that story is doing no one any favours. Getting a ten-year average inflation rate of 2.5% while allowing it to run above 4% in the near term requires a sharp and sustained reversal that the yield curve is no longer willing to assume for free. Warsh’s 16-17 June meeting will be the first real test of whether the Fed shares the bond market’s sense of urgency, or whether it intends to discover that urgency the hard way.
