A hot war, a trade war, a bad harvest, a snarl in shipping. Supply shocks have come so often over the past six years, KPMG chief economist Diane Swonk told Fortune, that they’ve started to sound like a drumbeat.
“With a drumbeat you get a rhythm,” she said, “and with the rhythm you learn.”
Households and businesses have learned to brace for the next price shock; but the bond market started pricing it in this week. The 10-year Treasury yield touched 4.92% on Thursday, its highest level since 2023 and just shy of the 5% red line feared by Wall Street. Treasury Secretary Scott Bessent’s attempts to strong-arm the bond market have been drowned out by the Iran war’s steady drumbeat, with oil back above $100 a barrel. Now Fed funds futures put the odds of a rate hike next week at roughly 75%, but the bond market, taking Fed Chair Kevin Warsh’s advice, isn’t waiting to play referee; it’s playing the ball.
Swonk’s fear is that letting the bond market do that tightening only makes the problem worse.
The bond market will overshoot, she said, because investors will demand more of a premium if they begin to doubt the central bank’s willingness to contain inflation. “The Fed controls the short end,” she added. “The bond vigilantes control the long end.”
All eyes are on the Consumer Price Index on Friday, which at least one Fed governor has indicated could be the tipping point in the hike-vs.-hold debate. But Thursday’s producer-price report, which actually informs the Fed’s preferred inflation index, the PCE, more than CPI does, pointed the wrong way. While it came in exactly as economists expected, rising 0.4% in August and 5.4% from a year earlier, diesel went up 24.1%, home-heating oil and distillates rose 22.8%, and eggs rose 32.2%.
“These are price increases firms can only partially absorb,” Joseph Brusuelas, chief economist at RSM, wrote on X Thursday. “They will be passed along going forward” into CPI and PCE.
Bill Adams, chief U.S. economist at Fifth Third Commercial Bank, argues the August report may already be stale; national diesel prices have surged further in September, he noted, while the AI buildout and blue-collar labor shortages are keeping pressure on everything from manufacturing components to repair and waste-collection services.
“September’s surge in diesel prices tips the odds of the Fed’s decision next week toward a hike,” Adams said.
Not everyone agrees—Grace Zwemmer, U.S. economist at Oxford Economics, estimates that the PPI details are consistent with just a 0.15% monthly increase in core PCE; not enough for a hike.
Regardless, Warsh is in an awkward spot. His Jackson Hole speech convinced investors a hike was more likely, but he didn’t say exactly what the bright line was. And if the Fed tries to let the Treasury market solve the problem, that carries its own risk. Robin Brooks, a Brookings fellow and former FX trader, argues that markets are interpreting the Treasury’s enlarged buybacks as a line in the sand, and then keep testing the line. Every attempt to restrain long yields invites investors to find out how far Washington is willing to go, potentially even shifting pressure from bonds into the dollar.
That’s why, for Swonk, this is no longer a one-print problem; it’s a credibility problem built from six years of shocks.
“He said the words that are needed,” Swonk said of Warsh. “Now the Fed needs to act on those words.”
This story was originally featured on Fortune.com