Two-year yields surge after hot CPI data and Fed comments

The bond market is reacting sharply once again.

US two-year yields climbed 19 basis points to 4.73% as investors absorbed a hot consumer price index report and remarks from Federal Reserve Governor Chris Waller. Waller indicated that a half-point rate increase in December was possible if core CPI came in at 0.3% or above. The reading was exactly 0.3%, and without a 1.2% decline in monthly used auto prices, it would have reached 0.4%. Waller also noted the broadening of price increases, which was reflected in the data.

Earlier this month, the market became less concerned about inflation because oil prices fell, but the Fed's view is that inflationary expectations are becoming embedded in 2027 pricing. I highlighted this in late October when Whirlpool announced it would raise prices by 7% effective December 3.

The Fed's earlier claim that tariff impacts would pass through the economy swiftly has proven incorrect. Firms such as Whirlpool experienced margin compression and initially resisted raising prices. Consumers had anchored on lower prices, and certain income groups are under pressure, but eventually companies conclude they must increase prices as steel and other input costs work through the supply chain.

In my view, the Fed is now experiencing that rude awakening. While oil prices have declined, product cracks remain extremely wide, capping the downside for now. I do not expect significant improvement without peace in the Middle East and Ukraine. Although some positive developments have occurred recently, no final agreement on either conflict appears near, so I believe risks are tilted toward deteriorating sentiment.

US Secretary of State Marco Rubio made the following statement:

At the moment, the talks have not been particularly productive because the Iranian demands are simply unacceptable, and in some cases they are outrageous, ridiculous, and detached from reality... We're not going to pay. Iran, you know, is demanding reparations. They should be the ones paying reparations because they're the ones that have, you know, destabilized the region for long periods of time. They're demanding pallets of cash, which the president made clear is not going to happen. If they want a nuclear energy program, they should have one, like many other countries around the world have. So there's things they can do, but just right now they just don't seem, you know, at that point. Now I think they want a deal. There's no doubt they'd like a deal too, but they're just not ready to make one apparently. But we're open to a little bit changes. But I don't think status quo is the right way to phrase this. Status quo means that things are going to stay static. They're not. They're going to continue to grow. What I'm saying to you is that the economic campaign is so devastating that right now there really is no need for major combat operations. The president has basically said that over the last few days, and that's what I told our European allies today.

That outlook is not encouraging.

As the election aftermath clears, it appears that little will shift, which is both problematic and inflationary. I would further contend that eventually the market will need to factor in a Democratic victory in 2028 and the accompanying fiscal stimulus, unless Republicans enact a strategic shift on Iran or tariffs.