MW This chart is a flashing warning sign that the Fed might yet rattle the markets with rate hikes by year-end

By Christine Idzelis

The bond market is signaling a 'stagflation lite' investment backdrop, one strategist says

Treasury yields were rising Monday, along with oil prices.

The U.S. bond market is increasingly concerned that accelerating inflation could pressure the Federal Reserve to raise interest rates to tamp down price pressures - even as U.S. stocks continued to trade within range of their record highs on Monday.

One chart highlighted by a Wall Street veteran suggests investors might want to pay more attention to the risk that the Fed will announce a sudden about-face and start raising borrowing costs again, even as many economists and market strategists have dismissed such an outcome as unlikely.

Rising inflation expectations embedded in 5-year Treasurys suggest the Fed may need to hike interest rates soon, which would increase borrowing costs. This market-based measure indicates inflation expectations are "close to breaking out above" 2.7%, which would put them near the highs last seen in 2023, DataTrek Research co-founder Nicholas Colas warned in commentary shared with MarketWatch on Monday.

At the same time, so-called real rates, which adjust for inflation, are relatively low, and seem to be trending lower. This represents a warning sign via markets that the U.S. economy is heading for a scenario that Colas described as "stagflation-lite."

Need to Know: The markets are in the early stages of pricing in stagflation. Here's what happens next.

To highlight this concern, Colas deconstructed the nominal daily 5-year U.S. Treasury yields BX:TMUBMUSD05Y in the chart below into two key components: the expected inflation rate and the real yield. As five-year forward inflation expectations have risen, real yields have declined. That could mean investors are underestimating the risk that another wave of inflation could soon start to push yields higher. Bond prices move inversely with yields.

DATATREK RESEARCH

"This is a worrisome investment backdrop for two reasons. First, it implies that the Fed will have to raise interest rates this year to convince markets that it is serious about its 2.0 percent inflation mandate," Colas said in written commentary. "Second, lower than average real rates suggest economic growth will be slower than the last 3 years."

Equity investors, though, have decided to look past these risks. They're focusing instead on strong growth in corporate profit margins.

"Neither market is necessarily 'wrong,' " Colas said, "rather, they are looking at different sets of fundamentals." But he cautioned that "the one risk that pops out from this analysis is the possibility that the Fed is behind the curve on inflation." That could become a serious risk for equity investors, if the central bank does start to signal that it is considering raising interest rates.

President Donald Trump, who has picked Kevin Warsh to succeed Jerome Powell as Fed chair, has loudly advocated for the Fed to cut rates. The Fed decided at its policy meeting last week to keep its benchmark rate steady.

"Last week, the bar to rate hikes came down," even if it remains high, said Neil Dutta, head of economic research at Renaissance Macro Research, in a note Monday. "Getting to a hike is probably a drawn-out process, with changes in the FOMC statement" and the Fed's Summary of Economic Projections, or SEP, "along the way," he said. "But the debate has shifted and the monetary policy hawks are ascendant."

So-called hawks are more inclined to fight inflation with interest-rate hikes and to refrain from cutting rates.

MarketWatch Live: Traders sharply raise bets on Fed rate increase this year

The S&P 500 SPX finished Friday at a new all-time high, rising for a fifth straight week, according to Dow Jones Market Data. The S&P 500 was trading about 0.4% lower Monday afternoon, while the Dow Jones Industrial Average DJIA fell 0.9% and the technology-heavy Nasdaq Composite COMP declined 0.2%, FactSet data showed, at last check.

Meanwhile, Treasury yields are broadly up this year, amid concern over higher oil prices triggered by the Iran war, with West Texas Intermediate crude (CL00) trading at more than $106 a barrel after midday Monday.

The Associated Press reported Monday that the United Arab Emirates said an Iranian drone started a fire at an oil facility in Fujairah, a hub used to avoid shipping via the Strait of Hormuz during the Iran war. This helped add upward pressure to Treasury yields.

The yield on the 10-year Treasury note BX:TMUBMUSD10Y was up about 6 basis points on Monday afternoon at around 4.44%, according to FactSet data, at last check. The 5-year Treasury yield BX:TMUBMUSD05Y was climbing about 7 basis points to around 4.10%, while the 2-year Treasury rate BX:TMUBMUSD02Y was jumping about 8 basis points to around 3.97%.

-Christine Idzelis

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May 04, 2026 14:58 ET (18:58 GMT)

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