Chart of the week: are bond markets losing faith in the 'Fed'?

Data-driven insights and analysis from our investment team every week.

This week, the chart shows the paths travelled over the last twelve months by the two components that make up US ten-year interest rates. It is clear that they have been closely correlated, but note that the axis on the left (real rates) is much wider than the axis on the right (expected “breakeven” inflation rates).

This makes sense. As inflationary pressures start to rise, bond markets push real rates higher across the maturity curve in anticipation that the central bank will increase official rates to quash these pressures—and vice versa. Or at least those are the dynamics we have predominantly come to expect over the last 30-plus years. But what would happen if markets began to worry that political pressures might lead a central bank to set rates below levels seen as appropriate and prudent?

The primary tail risk faced by bond investors is that inflation ultimately erodes more purchasing power than expected. Twice in the last year, we have seen inflation expectations make nascent attempts to diverge from real rates, only to quickly resume their prior convergence. Could July 2025 mark the start of a more definitive break? The currency markets seem to think so. Recent dollar weakness has defied much conventional wisdom. If “breakeven” inflation pricing begins to move north, it can do so swiftly. The relative scales on the left and right axes of the chart could even reverse.

Will we look back on this period and conclude that hubris led Trump to underestimate the power of bond markets to derail his agenda?