August 12, 2025

QuickTakes

Bond Vigilantes May Be

Lurking On Easying Path

The S&P 500 and Nasdaq jumped to new record highs following the release of July's CPI report today. The headline inflation rate held steady at 2.7%, while the core rate warmed a bit to 3.1%. Stock investors concluded that the Fed is even more likely to ease in September. Indeed, the CME FedWatch tool now shows that the odds of that happening are 94.4%. The 10-year US Treasury bond yield, however, edged up to 4.30%.

Fed officials and stock investors should keep in mind what happened at the end of last year, when the Fed cut the federal funds rate three times by a total of 100 basis points from September 19 to December 19 (chart). The 10-year bond yield rose 100 basis points over the same period.

At the end of last year, the Bond Vigilantes pushed back hard against the Fed's easing because they correctly perceived that the economy and labor market were in better shape than feared by Fed officials. In addition, inflation remained closer to 3.0% than to 2.0%, which is the Fed's official target.

July's weak employment report released at the beginning of this month, and today's July CPI report are widely expected to cause the Fed to ease. The stock market is always happy when a Fed Put is in play; the bond market, not so much this time. The Trump administration is pushing for the Fed to cut the federal funds rate to reduce the long-term borrowing cost of the federal debt and to lower mortgage rates. Last year's perverse experience serves as a cautionary tale.

We still believe in the resilience of the economy and the labor market. On the inflation front, we've come to think that while tariffs haven't boosted the overall inflation rate, they have kept it from falling to the Fed's 2.0% target in recent months. Inflation has been stuck closer to 3.0% than to 2.0%.

Let's have a closer look at today's CPI report:

(1) The core CPI services inflation rate stalled at 3.6% y/y during July (chart). Meanwhile, the core CPI goods inflation rate continued to rebound back above zero to 1.2%.

(2) The CPI for medical care services is showing signs of accelerating over the past few months (chart).

(3) Tariffs have had an inflationary impact on CPI durable goods inflation in recent months. These prices have tended to fall since the mid-1990s as globalization increased competition around the world, particularly in tradable goods. They were falling once again during the past two years following the 2022 spike in these prices. In recent months, they've been boosted by tariffs.

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