The long end has stopped taking orders from the Fed

A softer inflation print used to settle the argument. Equities rallied, yields fell, and advisers could hold duration on the understanding that the Federal Reserve had the wheel.

That reflex broke in August, and September confirmed it. US consumer prices rose just 0.1 per cent in July, yet the 30-year US Treasury yield still climbed past 5.33 per cent on 18 August as bonds sold off into good news.

The Fed then lifted rates by 25 basis points on 16 September, its first hike since July 2023. By late last week the 30-year yield had pushed above 5.5 per cent, its highest level since 2004.

Rajesh Puri, senior portfolio manager and head of global fixed income for Asian clients at Amundi, reads the move as a sign the long end has changed masters. Fed expectations no longer set it on their own, and his late-August market note flagged the risk weeks before the decision.

Cooler, but still running hot

“Moderating but elevated inflation is better than ‘runaway inflation’, but not good enough for a normal policy or market environment,” he says. “Price pressures are easing from peak levels but remain too high to restore normal policy settings or fully relieve households and markets.”

The mix of pressures explains why inflation is slow to fall. Rather than one shock fading, Puri counts several running at once.

Shelter and services are holding core CPI up while goods inflation cools, and tariffs are passing through to consumers. Weather and supply constraints are squeezing food costs, while energy is rising sharply on geopolitical tension.

Brent traded near US$94 a barrel when Puri wrote his note. It has since pushed past US$106 as the Strait of Hormuz standoff drags on, after Washington rejected Iran’s latest proposal to reopen the waterway.

The August CPI print, released on 11 September, bore out the energy side of his case. Headline prices rose 0.4 per cent for the month, holding the annual rate at 3.4 per cent, and petrol prices jumped 3.9 per cent to account for more than a third of the monthly rise.

That mix leaves consumers only partly relieved while the Fed stays constrained, Puri argues, “which leaves borrowing costs elevated (especially the long end) and growth uneven across rate sensitive sectors like housing, credit, and investment”.

The AI build-out arrives through the back door

The pressure Puri watches most closely barely shows up in the official data. Capital spending on artificial intelligence reaches inputs first, well before it reaches the shopping basket.

“This is a real inflation risk, but mostly as a force that keeps inflation from falling too quickly, rather than a source of an immediate CPI spike,” he says. “Over the next few quarters, the most likely impact is stickier inflation in a handful of upstream categories, especially data-centre construction labour, power, chips, grid equipment, and imported capital goods, rather than a broad surge in consumer prices.”

He rates the near-term risk as “moderate, but skewed to the upside”. The transmission is indirect and lagged, he notes, with margins absorbing some of the cost before consumers see it. If energy demand, labour shortages and supply chain constraints intensify together, he thinks the build-out could keep inflation above target well into 2027.

For portfolios, the consequence lands on the yield curve, because a slow bleed of upstream costs will not spike a monthly CPI print. It still gives the bond market a reason to demand more term premium for lending to Washington for 30 years.

“Inflation is now broad-based and more persistent, not just a temporary supply shock,” Puri observes.

Two markets, two stories

Equities and bonds have reached opposite conclusions from the same data, and Puri sees the divergence as the most telling signal available.

“Equities still reflect optimism around earnings resilience and a ‘no landing’ outlook, especially in large cap tech, while bonds are pricing a more troubling mix of sticky inflation, heavy Treasury supply, and rising term premium,” he says.

“That tension matters because the long end of the curve is increasingly being driven by fiscal and inflation risk rather than just Fed policy expectations, making duration harder to own.”

Heading into the meeting, positioning was split down the middle. Index swap markets priced roughly a 35 per cent chance of a hike against a 65 per cent chance of a hold, and the minority view won.

The Federal Open Market Committee voted 12-0 to lift the target range to 3.75 to 4 per cent. Chair Kevin Warsh told reporters that “inflation is too high and has been for too long”, and the committee’s projections now point to one more hike this year and another in 2027.

Puri’s note warns that “a surprise hike would likely test equity valuations and consensus positioning directly”. On the day, the S&P 500 fell 0.5 per cent and the 10-year yield touched 5.04 per cent intraday, its highest level since 2007.

He points to gold’s strength as the same signal from another angle, with investors still paying for protection against inflation, fiscal and policy risk while equity indices price a soft landing.

Where the case could break

There is of course a counter argument, because higher-for-longer calls do not always hold. In October 2023, similar reasoning drove US Treasury yields past 5 per cent on heavy supply and a rising term premium, before the long end rallied hard into year end as the Fed pivoted. Duration positions built on term premium can unwind faster than the thesis behind them.

The August data also carries a warning for the sticky-inflation camp. Core CPI eased to 2.4 per cent over the year, its lowest reading since March 2021, even as petrol lifted the headline number. A resolution in the Gulf could pull energy prices down quickly, and the term premium argument might just fall with them.

The AI argument also has a flip side worth noting, since capital spending that adds cost pressure on the way up would remove a significant source of demand if the cycle slows. A capex pullback could ease inflation from a different direction.

Puri notes the pass-through is gradual and partly absorbed in margins, which means the effect is likely to show up gradually rather than all at once.

Selectivity over direction

The portfolio conclusion follows from the diagnosis, and Puri argues the environment rewards choosing exposures over calling a direction.

“The current macro environment is evolving quickly, driven by a range of underlying forces, which makes global markets highly selective rather than broadly directional,” he says. “In credit, only certain pockets look attractive, while in duration, timing and positioning matter materially when deciding where to add or reduce exposure.”

The same caution applies to the currency layer, which advisers often leave on autopilot. Puri notes the US dollar remains vulnerable to a fresh inflation surprise or a risk-off move in equities. He also expects emerging markets to lose any short-term relief from a Fed on hold if energy prices keep climbing, and with the Fed now hiking and Brent still rising, that support perhaps looks thinner again.

Australian advisers face a local version of the problem. The Reserve Bank held the cash rate at 4.35 per cent on 11 August, and governor Michele Bullock said the board weighed only two options, hold or hike.

The board announces its next decision on 29 September, and all four major banks expect a 25 basis point rise to 4.6 per cent, which would be the highest cash rate since 2011.

Middle East conflict and oil supply shaped the RBA’s thinking in August. Those are the same inputs that feed Puri’s view from the other side of the world.

“The good news is that there are so many different narratives,” Puri says. Dispersion is where an active manager earns the fee, and it shapes the question advisers can take into their next manager meeting. Dispersion rewards the managers who pick correctly, and it charges everybody else for the attempt.