A more dovish Fed did little to ease concerns at the long end of the Treasury market. Following the July meeting, short-term yields declined while 30-year yields climbed to their highest level since 2007, reflecting concerns about inflation and policy credibility. Our base case remains for the Fed to stay on hold through 2026, but rising long-end yields could eventually narrow policymakers' room for patience.

This week, the Federal Reserve left policy rates unchanged, while Chair Warsh struck a notably dovish tone. He downplayed the inflationary implications of the AI buildout, suggested that tighter financial conditions via higher market rates could do some of the Fed’s work, and argued that confidence in the inflation target could help anchor inflation expectations. Ironically, however, such dovish signaling may increase the likelihood that more restrictive policy is ultimately required. 

Markets appeared to draw a similar conclusion. The immediate reaction was a sharp twist steepening of the yield curve, with two-year yields falling and 30-year yields rising to the highest since 2007. While the decline in short-dated yields reflects a more dovish near-term policy outlook, the rise in long-end yields signals growing concern that Chair Warsh may prove unwilling to act aggressively enough should inflation remain elevated. The bond market is effectively testing the Fed's credibility. 

Our base case remains that the Fed stays on hold through the remainder of 2026. But if inflation fails to moderate, rising inflation expectations and a higher term premium are likely to drive long-end yields higher, forcing policymakers to tighten in order to restore credibility and regain control of the bond market—regardless of their preferred course. The recent rise in long-end yields serves as a warning that the bond market, not the Fed, may ultimately determine how long policymakers can afford to remain patient.