Oil at $98 and Rising Inflation Expectations Leave the Fed Nowhere to Go
Equities are calm, credit is tight, and the soft-landing narrative holds. But the bond market moved today in a way that deserves more attention than it's getting.
Palmer's note: Was interesting that Tom McClellan just posted an article about the High Yield A/D divergence ([link](https://www.mcoscillator.com/learning_center/weekly_chart/high_yield_bonds_flash_warning/)). His oscillator applied to High Yield breadth hasn't flipped yet, though has been threatening to. Anyway, starting to pay a little more attention to the bond market these days.
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The S&P 500 is at 7,424 today, sitting about 10% above its 200-day average and up a bit over 2% on the week. On the surface, things look fine. But look a little closer and the picture gets more interesting.
The most important number today isn't in the stock market. It's in the bond market, where the 10-year breakeven inflation rate (basically, what bond investors collectively expect average inflation to be over the next decade) jumped by about 7 basis points (roughly 0.07%) in a single session to 2.48%. That might sound tiny, but for that measure it's a big move. At the same time, crude oil hit $98 a barrel, up almost 3% on the day and over 3% on the week. And copper, which tends to track global industrial demand pretty reliably, is up 3.5%.
So the commodity markets are signaling something real about inflation pressure, and the bond market is starting to agree. Meanwhile, the Federal Reserve has been on hold since March, projecting maybe one rate cut sometime in 2026, but only if goods inflation (prices on actual stuff, not services) comes back down. With oil at $98 and tariffs on EU auto imports potentially going from 15% to 25%, that "one-time pass-through" story is looking shakier.
The incentive picture is pretty clear. The Fed cannot cut rates if inflation expectations are rising. Companies are passing tariff costs to consumers because they can: demand hasn't broken. And the bond market, which tends to be a more cold-blooded judge of these things than the stock market, is starting to price in a longer stretch of elevated inflation. The 10-year Treasury yield rose today while the 2-year yield actually fell. That "steepening" pattern (long rates up, short rates down) usually means the market is pricing in growth and inflation together, not a recession.
What's not in the headlines: Gold is at $4,734 an ounce, which is historically very high. But here's the odd part: speculative traders (the hedge fund types who move fast on momentum) are currently sitting at near-maximum short positions in gold, meaning they're betting heavily that gold goes down from here. That's a crowded trade. If oil stays near $95+ and inflation expectations keep drifting up, a lot of those bets start to look wrong at the same time, and the resulting scramble to cover can move prices fast.
Credit markets (corporate bonds) are not panicking. High yield spreads (the extra interest rate companies with weaker credit have to pay compared to the US government) are actually quite tight by historical standards. Tom McClellan flagged this week that his breadth measure for the high yield bond market (tracking how many bonds are advancing vs declining internally) is barely positive and threatening to roll negative. That's worth watching because credit breadth tends to deteriorate before the headline spread numbers do.
Watch for: The 10-year breakeven inflation rate holding above 2.5% over the next couple of weeks. If it stays there while oil stays near $95+, the Fed's projected rate cut path becomes very hard to defend, and longer-term bonds will likely sell off further. That's the point at which the stock market would have to start pricing in something the bond market already knows.
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Sources: [Bloomberg, Fed Holds Rates (March 2026)](https://www.bloomberg.com/news/articles/2026-03-18/fed-holds-rates-steady-still-projects-one-rate-cut-in-2026) · [Bloomberg, IMF on Rate Cuts (April 2026)](https://www.bloomberg.com/news/articles/2026-04-02/imf-says-fed-has-little-scope-for-interest-rate-cuts-this-year) · [Bloomberg, Tariffs (May 2026)](https://www.bloomberg.com/news/newsletters/2026-05-08/trump-s-tariffs-will-keep-fueling-trade-debates-and-disputes) · [McClellan, HY Bonds Flash Warning](https://www.mcoscillator.com/learning_center/weekly_chart/high_yield_bonds_flash_warning/) · Market data: mkt dashboard, May 11, 2026
