The consensus on Wall Street has spent months treating rate hikes as a tail risk. The Treasury market rate hikes signal now embedded across the yield curve suggest the bond market has stopped being polite about it.
On Friday, the 2-year Treasury yield jumped by 12 basis points to 4.17%, its highest level since February 2025. That earlier peak was the product of a different trade entirely: the market was then pricing in rate cuts, three of which duly arrived. Now the same instrument is pricing in the opposite. Since the end of February, the 2-year yield has risen by 79 basis points, swinging from a rate-cut expectation to pricing in multiple hikes. It sits 54 basis points above the Effective Federal Funds Rate.
The trigger was the latest jobs report, which, according to analysis published by Wolf Street, confirmed three months in a row of substantial job growth, including upward revisions to the prior two months, with the three-month average at its highest level since March 2024. A resilient labour market removes the Fed’s last defensible reason to delay tightening. It hands inflation the top spot on the worry list.
Inflation Running Well Above Target Creates Treasury Market Rate Hikes Pressure
Both the CPI and the Fed-favoured PCE price index are likely to show inflation above 4% for May, double the Fed’s 2% target and above that target for over five years. Crucially, inflation was already rising before the energy shock in March, and has since spread beyond energy into other parts of the economy. The 4% figure is not a spike to be looked through. It is a sustained condition.
The 3-year Treasury yield also rose 12 basis points on Friday to 4.22%, up 81 basis points since the end of February, and now 59 basis points above the EFFR. The 6-month yield, which reflects bond market expectations for Fed policy over the next three to five months, climbed to 3.80%, sitting 18 basis points above the EFFR. That spread is a concrete signal: the bond market is pricing the initial rate hike for later this year, not next.
This is not merely expectation-setting. The bond market is applying pressure. If the Fed opts to “look through” inflation that is running at twice its target, the long end of the curve will make that decision expensive. The 30-year yield rose back above 5% on Friday, after hovering just below that level for over a week. On 19 May it had hit 5.19%. The 10-year yield rose 8 basis points to 4.55%.
Inside the FOMC: Dissent Is Growing
The internal dynamics at the Federal Reserve add another layer to this picture. According to CNBC, the rate-setting Federal Open Market Committee voted to hold its benchmark rate in the 3.5% to 3.75% range, but the meeting produced four dissenting votes, the most since 1992. That level of internal opposition does not suggest a committee that is comfortable with its current stance.
The picture from the FOMC minutes is consistent with the yield moves. A Chase summary of those minutes noted a majority view that “some policy firming” would likely become appropriate if inflation kept running above target. That is the Fed’s own language for rate hikes. The bond market has apparently been reading the same document.
Newly minted Fed chair Warsh faces a compounding problem. Persuading a majority of FOMC voting members that a cut is warranted in this environment looks close to impossible. Persuading that same majority that a hike is not warranted, later this year, may prove equally difficult. The four dissents already on record suggest the committee’s centre of gravity is shifting.
The longer-term picture is harder to dismiss. Treasury debt is growing at over $2 trillion a year. The bond market’s concern is twofold: that inflation in the 3% to 4% range, or higher, will be tolerated rather than fought, meaning yields must rise to preserve any real return; and that the trajectory of US government borrowing is not sustainable in any conventional sense of the word. A 10-year yield of 4.55% is, as Wolf Street noted, arguably low for this inflationary environment, particularly if the Fed and the government are aligned on running the economy hot to erode the real burden of the national debt. The maths of achieving a 2.5% average inflation rate over a decade while allowing 4%-plus readings in the near term is uncomfortable. The bond market is starting to say so out loud, and four FOMC dissenters appear to agree.
