The reaction function

A 9-3 decision with three hawkish dissents marks a sharp break for a Committee that reached unanimity just months ago. The vote highlights a clear split over how to weigh persistent, above-target inflation against a largely unchanged labor market.

The statement explicitly cites Middle East conflicts and energy supply shocks as key drivers of inflation. This begins to incorporate geopolitical risk into the Fed’s reaction function. Because monetary policy targets demand by adjusting borrowing costs, the Fed effectively absolves itself from attempting to resolve supply-side disruptions directly. A rate hike does nothing to reopen pipelines or clear energy shipping lanes.

By officially acknowledging supply-side drivers, the Committee implicitly concedes that a critical component of current inflation sits outside its toolkit. This inclusion serves as both a realistic admission of policy limits and a preemptive explanation for prolonged disinflation, signaling that monetary levers alone cannot solve this phase of the inflation problem.

Transparency at the Fed

The market forgets that Fed policy was not always parsed in real time. For most of its history, the central bank did not even announce rate decisions on the day they were made. Meeting minutes and policy rationale were routinely withheld for years. Congress forced the Fed’s hand. Through FOIA and Humphrey-Hawkins reporting, lawmakers systematically unwound decades of institutional opacity. The modern regime of press conferences, dot plots, and forward guidance is a recent development. It has trained investors to treat Fed commentary as an oracle rather than what it actually is: an institutional baseline that is revised constantly and frequently wrong.

Warsh clearly understands this dynamic. He has repeatedly warned markets to “play the ball, not the referee” while actively dismantling the Fed’s guidance apparatus. He has questioned whether post-meeting press conferences should continue past this year. At the same time, he has rejected forward guidance and stripped legacy market-management language from the FOMC statement.

His underlying thesis is accurate: markets have overindexed on Fed guidance that was never designed to bear such weight. The dot plot is merely a snapshot of current conditions, not a policy commitment.

During the press conference, Warsh acknowledged that five years of persistent inflation created market skepticism that a few weeks of policy cannot undo. His critique here is valid. The Fed’s projections have missed the mark repeatedly over a multi-year stretch. Yet market participants consistently treat those forecasts as authoritative, reallocating portfolios around projections that are routinely overturned by revisions.

However, dismissing over-reliance on Fed guidance does not shield Warsh from critique. Modernizing the Fed’s outdated analytical framework with outside perspectives is a sound initiative. Bringing in outside experts to study AI’s effect on productivity or inflation is a reasonable idea on its own. The issue lies in execution.

Rather than offering interim clarity, Warsh repeatedly deflects tough questions by citing these task forces, leaving markets stranded in ambiguity. Every time he faces a hard question about policy today, he points to a task force for tomorrow. Without transparent selection criteria for members or a clear mandate on how the Fed will use their findings, investors cannot evaluate the outcome. As these reviews drag on, every pressing policy question risks being brushed aside with a generic promise that a task force is studying it.

Elevating five task forces over the standing Committee shifts institutional authority. It may ultimately prove to be a smart modernization of Fed thinking. Or it may simply be a chair hiding behind process while policy drifts.

The market’s initial verdict was not clarity, but confusion. AllianceBernstein called the press conference internally contradictory. Principal Asset Management labeled it one of the most confusing in recent memory. Some analysts noted that while the market heard a dovish tone, the prepared remarks laid the groundwork for a rate hike. That inconsistent messaging is what’s driving near-term uncertainty. It is one of the reasons the long end of the yield curve is spiking. Credit investors and vigilantes are telling the market they want rate hikes and clarity.

The 30 YR

The 30-year Treasury yield surged to 5.267%, touching its highest level since 2007. The move was instantaneous, jumping roughly 10 basis points in real time while Warsh was still speaking.

The short end moved in the opposite direction. Two-year yields fell in real time as Warsh’s comments signaled a dovish lean, prompting traders to price in a near-term rate pause. The long end refused to follow, as 30-year yields spiked that same day. Pricing in persistent inflation, energy risks, and real yield pressures, the long end drifted higher, acting as a direct rebuke to the message being delivered. This dual-direction move illustrates the uncertainty that the market faces. The short end is trading on Warsh's stated preferences, while the long end is pricing what the macro data demands.

The reaction from the bond market carries more weight than any statement from the podium. The 30-year leaves no room for ambiguity. It forces investors to simultaneously price three decades of growth, inflation, and institutional trust. A sharp yield spike during a press conference signals that institutional money did not gain clarity. Instead, investors demanded a higher term premium to hold duration under an unproven, ambiguous policy framework.

Conclusion

Reduced communication does not automatically erode central bank credibility. Warsh makes a valid point regarding the limits of forward guidance. Identifying market over-reliance on central bank guidance, however, is distinct from managing it effectively. Warsh concluded the press conference without resolving policy ambiguity. Rather than clarifying the immediate decision, he relied heavily on five future task forces, driving the 30-year Treasury yield to a year-to-date high. The bond vigilantes are making it clear they remain unconvinced by his execution.

We maintain that current policy is accommodative rather than neutral, making a continued hold increasingly difficult to justify. Escalating conflict in the Middle East continues to support elevated energy prices, while labor market data stays resilient. Combined, these factors erode the case for holding rates.

We project the Fed will hike once or twice before year-end.

ZCR

Some personal thoughts here. While I respected Powell, who was always a consummate professional, he at times lacked the foresight and leadership to navigate the late 2020s inflationary period. We have for five years missed our benchmark inflation target.

It is easy to criticize Powell post facto, and I do acknowledge that the job of chair is not easy. However, new leadership was needed here to step away from some of the antiquated tools and ideas of the Fed.

Warsh comes in as a breath of fresh air. With this new tenure and regime at the Fed here are some of his proposed changes and notable updates:

• Forward guidance abolished - Warsh noted that financial markets perform best when they react to incoming data from the real economy, allowing them to better price both likely outcomes and tail risks.

• Task Force - The task forces will examine Fed communications, the balance sheet, data utilization, productivity, and the inflation framework.

• Rejection of the idea of framing the dual mandate as a trade off.

• Inflation Target- Warsh sees no reason to revisit the 2% inflation objective until the Fed reestablishes its ability to deliver on it.

• Seeking the use of more realtime data than antiquated ones.

Overview

The Summary of Economic Projections, or SEP, is the quarterly report card that tells us exactly where Fed officials think the U.S. economy and interest rates are heading. Released alongside the FOMC policy statement in March, June, September, and December, it strips away the immediate rhetoric and gives us the raw numbers.

The report aggregates individual, anonymous forecasts from every FOMC participant to provide the median, central tendency, and full ranges for four foundational metrics: real GDP growth, the unemployment rate, PCE inflation, and core PCE inflation. By looking at these projections across the next three calendar years and into the longer run, we can map out the structural shifts in Fed thinking and anticipate how monetary policy will actually evolve.

We will note that for the latest SEP release, Warsh declined to submit a projection, consistent with his longstanding skepticism of the SEP in its current form.

The June 2026 SEP reflects a material shift in the committee’s macro outlook. Relative to the March projections, headline PCE was revised up 90 basis points to 3.6% and core PCE up 60 basis points to 3.3%. Crucially, the median end-2026 funds rate moved from 3.4% to 3.8%, implying at least one 25 basis point hike before year-end.

The committee also pushed the timeline to its 2% target out to 2027. Taken together, these projections remove any near-term basis for rate cuts and firmly shift the distribution of outcomes toward further tightening.

SEP Table

The Inflation Revision

The March SEP projected both headline and core PCE inflation at 2.7% for 2026. The June revision moved headline to 3.6% and core to 3.3%. This represents a material 90 and 60 basis point upward revision in a single quarter. With these changes, the committee has formally abandoned the view that inflation was on a smooth glide path back to target.

The 2027 projections confirm this sticky trend. PCE was revised from 2.2% to 2.3% and core PCE from 2.2% to 2.5%. The committee now projects that a full return to 2.0% will take until 2028.

The distribution data reflects a committee without a clear consensus. The 2026 PCE range runs from 2.7% all the way to 4.1% for headline, while core spans from 2.6% to 3.5%. The central tendency for 2026 headline PCE sits at 3.5% to 3.7%. This range is 80 to 100 basis points above the prior median, confirming that the upward revision reflects a broad consensus rather than a shift driven by outliers.

The Rate Path

The median fed funds rate projection for year-end 2026 rose 40 basis points from 3.4% in March to 3.8% in June. The 2027 median increased from 3.1% to 3.6%, and the 2028 median moved from 3.1% to 3.4%. The longer-run neutral rate held flat at 3.1%.

The dot plot shows a material rightward shift, with the full 2026 range climbing to 3.4% through 4.4% compared to March’s 2.6% through 3.6% span. The largest clusters sit in the 3.6% to 3.8% and 4.1% to 4.3% buckets. Notably, no participant now projects a year-end rate below 3.38%.

By 2027, the distribution runs from 2.9% to 4.4%. This 150 basis point variance reflects a committee operating without a consensus thesis beyond the near term. The duration of the energy shock and the pace of core disinflation remain genuinely unresolved internally.

Growth

The 2026 median GDP projection was trimmed from 2.4% to 2.2%, with the central tendency shifting down from March’s 2.2% to 2.5% range to a lower 2.0% to 2.3% span. Despite the revision, a 2.2% growth rate indicates an economy that is not contracting, even as headline PCE reaches 3.6% and the funds rate above 3.75%. Looking further out, 2027 GDP remains unchanged, the 2028 median ticked up to 2.2%, and the longer-run growth rate held flat at 2.0%.

Participants now view growth risks as heavily weighted to the downside. The 2026 distribution confirms this shift, with the largest clusters pooling in the 2.0% to 2.1% and 2.2% to 2.3% brackets. This marks a clear departure from March, when upside and downside growth risks were much more evenly balanced.

Unemployment

The 2026 median unemployment projection dipped slightly from 4.4% to 4.3%, showing that the current labor market is holding up better than the committee assumed in March. The committee projects unemployment to stay flat at 4.3% through 2027 before easing to 4.2% in 2028. The longer-run estimate remains unchanged at 4.2%.

The risk distribution is tilted to the upside, showing more participants believe unemployment could exceed their baseline projections rather than fall below them. Most submissions clustered tightly around the 4.2% to 4.3% range, with only a few outliers stretching into the 4.4% to 4.5% bracket.

The Implication

The June SEP formally shifts the Fed’s macro outlook in a stagflationary direction. The committee raised inflation projections, lowered growth expectations, and delayed the return to target. This updated data effectively closes the door on the near-term easing narrative.

The critical long-term implication rests with Chair Warsh. He has abolished forward guidance, withheld his own projection, and launched a structural review of the inflation framework. Through these actions, the Chair is signaling an institution in transition.

During the session, Warsh framed AI as “American Ingenuity.” That productivity boost may be the only path to 2% inflation without a recession. If technology drives higher output alongside modest growth, the Fed could hold rates steady, or even ease, while inflation falls naturally.

After five years of missing its target, the Fed finally has leadership willing to discard tools that do not match today’s economy.

ZCR

The Beige Book is the Federal Reserve’s summary of current economic conditions across its twelve Districts, published eight times per year. The document compiles qualitative, anecdotal reports from businesses, banks, community organizations, and local market contacts. This report reviews that key data and outlines the core implications for the broader market.

Economic Activity
Ten of twelve Districts reported slight to moderate economic growth. Cleveland led with a moderate pace driven by data center construction, while Richmond, Atlanta, Dallas, and Minneapolis notched modest growth. Boston, New York, Chicago, St. Louis, and Kansas City followed with slight gains. On the flip side, Philadelphia recorded a slight decline, and San Francisco reported flat activity.

Manufacturing provided the standout national headline, with nine Districts logging modest to strong gains. However, this is not a broad-based industrial recovery. Contacts across multiple regions explicitly tied this strength to data center buildouts and defense demand, meaning growth remains highly concentrated in two specific end markets.

Labor Markets
Employment remained essentially flat across eleven Districts, with only New York reporting a slight increase. The overall environment looks like a low-hire, low-fire market. Contacts described highly selective hiring focused strictly on critical roles and replacing natural attrition.

At the same time, AI adoption is visibly shifting demand by compressing entry-level roles while increasing the need for specialized technical skills. Wage growth stayed modest to moderate and largely tracked inflation, though several Districts noted more frequent cost-of-living adjustments tied directly to higher fuel costs.

Prices
Prices rose at a moderate to strong pace, with most Districts reporting faster inflation than the prior Beige Book. The dominant driver across all regions is energy costs linked to the Iran conflict. These costs are transmitting directly through fuel, shipping, fertilizer, packaging, and groceries. Non-labor input costs are rising faster than selling prices in most Districts, producing widespread margin compression. Consumer-facing firms are absorbing the largest share of this pressure. Several contacts described the transmission bluntly, noting that everything gets to the consumer with diesel.

The Consumer
Spending is bifurcating sharply by income. Higher-income households remain resilient, maintaining strong demand for luxury and premium goods.

In contrast, middle-income households are under clear strain, with contacts noting that families are squeezing more life out of every dollar. Low-income households show material stress. This segment is increasingly turning to credit cards for essentials, cutting back on retail visits, and driving up demand for social services. Auto demand is soft across the board. Buyers are substituting toward used vehicles and hybrids, a shift driven strictly by high fuel costs rather than standard consumer preference.

Banking and Credit
Banking conditions remained stable on the surface, but early stress signals are beginning to appear. Multiple Districts noted rising delinquencies across residential mortgages, consumer loans, and agricultural credit. While credit card balances continue to grow, the increase is concentrated in non-discretionary categories. Consumers are leaning on credit to fund gasoline and groceries rather than discretionary spending.

Agriculture
Conditions were unchanged or weaker across most Districts. Fuel and fertilizer cost spikes are compressing margins. Several regions reported drought pressure and reduced farm income expectations. The energy shock creates a dual burden for the agricultural sector. It simultaneously functions as a severe production cost spike for producers and an inflationary pressure on the end consumer.

Implications
The FOMC meets on June 16 to 17, marking the first session chaired by Kevin Warsh. This Beige Book provides no clean read for the committee.

We see three key takeaways for portfolios:

• The Data Center and Defense Complex: Manufacturing in these sectors provides a genuine structural offset to broader macro softness. Multiple Districts independently confirmed this trend, driven by the ongoing increase in defense and AI spending.

• Consumer Bifurcation: The consumer split is now well-documented at the ground level. Retailers serving middle- and lower-income households face a materially weaker demand environment than those catering to the upper-income bracket.

• Credit Quality Shift: Rising delinquencies in mortgages, consumer lending, and agricultural loans across multiple Districts are early signals of a shifting credit cycle. Equity markets have not yet fully priced this risk.

Economic growth remains present but narrow and uneven, while employment stays frozen rather than deteriorating. Inflation is accelerating across most Districts, driven by an energy supply shock that monetary policy cannot address at the source and that economists hope will prove transitory. Meanwhile, widespread margin compression, a sharply bifurcated consumer, and emerging credit stress across several sectors signal mounting structural challenges. Ultimately, the Fed has no clean policy response available.

ZCR

For nearly two decades, the defining feature of the global macro environment was declining interest rates. Every crisis ultimately pushed yields lower. Growth slowed, central banks intervened, liquidity expanded, and sovereign debt became the preferred global safe haven. The 10-year Treasury moved from 15% in the early 1980s to below 1% during the pandemic era, conditioning investors to believe that bonds always rally when uncertainty rises. That regime has ended.

Bond yields are rising globally, not just in the United States. Japanese Government Bonds are trading at levels not seen in decades. German Bund yields continue to climb despite weak European growth. UK Gilts remain structurally elevated. The move is broad, persistent, and increasingly disorderly. This matters because sovereign yields represent the foundation of global asset pricing. When the risk free rate reprices higher, every asset class must eventually adjust around it.

The market is beginning to confront a possibility it has largely avoided since 2008: what if inflation is not temporary, deficits are no longer financeable at ultra low rates, and central banks lose the ability to suppress yields without creating even larger problems elsewhere?

We believe the current rise in yields is not being driven by one isolated factor. It is the combination of four structural forces colliding simultaneously:

• A renewed energy and commodity shock

• Persistent inflation and fiscal deterioration

• Foreign selling and declining Treasury demand

• Federal Reserve leadership transition and credibility uncertainty

Individually, each factor would matter. Together, they may represent the beginning of a new bond regime.

The Global Move

The first mistake investors make during periods like this is assuming the problem is isolated to the United States. It is not.

Japanese 30-year Government Bond yields have pushed to multi-decade highs as the Bank of Japan loses control of the yield suppression policies that defined the last generation. For decades, Japan exported deflation and structural liquidity to global markets through zero-bound rates and its companion yen carry trade. That global liquidity tap is now closing as domestic inflation forces the BOJ to retreat from extraordinary yield curve intervention.

Germany is experiencing a parallel repricing. Bund yields continue to clear higher despite stagnant Eurozone industrial activity and recessionary domestic backdrops. This breaks a long-standing market heuristic: historically, weak growth reliably pushed sovereign yields down. Today, structural inflation risk and relentless debt issuance are completely overwhelming growth concerns, forcing markets to demand a higher premium for European duration risk regardless of economic health.

The United Kingdom provided the clearest warning shot during the 2022 Gilt crisis. Following the announcement of aggressive unfunded fiscal stimulus, yields exploded higher in a matter of days as investors questioned fiscal credibility and liquidity rapidly deteriorated across the pension system. While the Bank of England's emergency intervention stabilized the market, the core lesson remained: sovereign bond markets can lose structural confidence far faster than policymakers can restore it.

This is no longer a series of localized volatility events. It is a synchronized, global repricing of sovereign risk, where the United States simply serves as the primary epicenter because the Treasury market remains the foundational collateral system of global finance.

Oil Shock

In our April publication we sourced the IEA's own language: the largest oil supply disruption in the history of the global oil market. Global supply collapsed 10.1 million barrels per day in March to 97 million, falling further to 94.2 million in April, as Hormuz flows dropped from above 20 million barrels per day in February to 3.8 million. Brent futures hit $130 with spot markets touching $150, roughly $60 above pre-conflict levels in six weeks. By end of May, Brent had retraced to approximately $92, as markets priced a prospective 60-day ceasefire that President Trump has not signed. UBS confirmed as of May 28 that vessel traffic shows little evidence of improvement and the 400 million barrel coordinated reserve release remains the only active buffer against a structural supply deficit that has not been resolved.

This shock hits an inflation baseline that was already sticky. Core PCE is running near 3.2%, shelter remains elevated, and services inflation has not broken. April US headline CPI printed at 3.8%, the highest since late 2023, prior to the full pass-through of $130 oil into transportation, food, and manufacturing. The energy shock has returned upward pressure to inflation.

The long end of fixed income prices long-term inflation expectations. If markets anchor on an inflation floor above target due to a protracted Hormuz disruption, nominal yields must incorporate an expanding term premium. The 10-year breakeven inflation rate has risen from 2.21% in late 2025 to trade near 2.45% by May 2026.

The Federal Reserve cannot ease into 3.0% core PCE without unanchoring inflation expectations, nor can it tighten into a supply-driven growth shock without risking a severe credit event. In 1979, Volcker’s commitment to restrictive policy was explicit and credible because market participants could test it over time. The current macro environment offers no equivalent clarity. A new chair taking the helm, an FOMC internally fractured by numerous dissents in April, and explicit political pressure from the Executive branch create genuine uncertainty regarding where terminal policy settles. Bond markets do not require an active crisis to reprice duration; unresolved uncertainty is entirely enough, and the long end of the curve is already reflecting it.

Foreign Buyers

For decades, the Treasury market relied on structural, non-price-sensitive foreign demand to suppress yields and cheaply finance expanding US deficits. We are seeing an unwinding in that framework.

​March 2026 TIC data confirms China reduced its Treasury holdings to $652.3 billion, the lowest level since September 2008. Regulators have reportedly instructed domestic banks to cap US debt exposure to mitigate volatility and concentration risk. This capital has rotated into hard assets; the PBOC extended its gold-buying streak to 17 consecutive months, bringing official reserves to 2,313 tonnes, or roughly 9% of total FX reserves.

​Japan presents a more immediate structural headwind. Japanese investors divested a net $29.6 billion in US bonds during Q1 2026, the largest quarterly reduction in nearly four years. As domestic JGB yields rise toward 2.5%, the historical incentive to hold US debt disappears. The Bank of Japan has nearly halved its monthly JGB purchases to ¥2.9 trillion, allowing domestic lifers and pension funds to capture competitive returns at home without paying foreign exchange hedging costs. This tapering is estimated to add 20 to 50 basis points to the US 10-year yield over the medium term.

​This retreat is exacerbated by mark-to-market pressure. Foreign investors logged $142.1 billion in valuation losses on long-term Treasuries in March alone. These falling prices accelerate the incentive to liquidate to protect regulatory capital ratios. The official sovereign sector is structurally exiting, leaving private domestic demand to absorb the remaining volume.

​Concurrently, US supply requirements are expanding. The FY2026 projected deficit stands at $2.06 trillion, requiring $166 billion in new issuance monthly. Federal interest payments alone hit $530 billion in the first half of FY2026, making net interest the second-largest line item in federal spending, outstripping both defense and Medicare. Annualized interest costs are on track to touch $1 trillion this fiscal year and $2.1 trillion by 2036.

The auction data confirms this supply is increasingly expensive to place. Three consecutive late-March auctions across the 2-year, 5-year, and 7-year tenors each underperformed on bid-to-cover, tail, and primary dealer absorption. The May 12 10-year auction extended the trend: $42 billion cleared at 4.468% on a bid-to-cover of 2.13, a 5.5 basis point tail, and indirect bidder participation down to 64% from 74.5% in March.

Higher yields expand interest expense, boosting borrowing requirements and forcing larger auctions into a retreating foreign bid. Foreign holdings now represent just 28% to 30% of marketable debt, down from nearly 50% in 2008. Domestic balance sheets have absorbed the slack, but that capacity is finite. As issuance outpaces structural demand, the market will demand a permanent fiscal risk premium embedded in the long end of the curve.

The Fed

The Federal Reserve leadership transition is complete. The Senate confirmed Kevin Warsh as the 17th Federal Reserve Chair by a 54 to 45 vote on May 13, 2026, marking the most partisan confirmation in the institution’s history. Jerome Powell’s term expired two days later. Warsh inherits a restrictive macroeconomic backdrop with zero clean policy choices.

The FOMC held the federal funds rate steady at 3.50% to 3.75% at its April 29 meeting. The 8-4 decision delivered the highest number of dissents on a single FOMC vote since October 1992, reflecting deep internal fragmentation over sticky inflation. The April minutes confirmed a majority of participants view further policy firming as appropriate if core PCE remains stuck near the current 3.2% print.

CME FedWatch data captures the total collapse of the rate cut narrative. For the December 9, 2026 meeting, the probability of an ease sits at 0%. A hold at the current 3.50% to 3.75% range carries a 51.6% probability. Meanwhile, an aggregate hike is priced at 48.4%: 37.7% for a 25 basis point move, 9.6% for a 50 basis point move, and 1% for a 75 basis point move. Twelve months ago, this market priced multiple 2026 cuts. Today, it reflects a coin flip between a hold and a hike.

Warsh assumes control facing an immediate policy trap: the market prices a 48% probability of a hike while the executive branch demands cuts. This political pressure directly reinforces the trap here. A Fed that cannot ease without unanchoring inflation expectations, nor tighten without triggering credit stress, leaves the long end of the curve without an institutional anchor.

With a 2 trillion dollar annual deficit, a divided FOMC, and a foreign bid in structural retreat, the US long end must price both the inflation uncertainty and the supply risk simultaneously.

Where are Yields going?

We focus on three data series in this section: the March 2026 SEP, the 10-year real yield, and the 10-year breakeven inflation rate.

The March 2026 SEP projections contain one revision that the market largely overlooked. The Fed lifted its longer-run GDP estimate from 1.8% to 2.0% while leaving longer-run PCE inflation and unemployment unchanged at 2.0% and 4.2% respectively. What we believe the Fed is hinting at here is a supply-side shift, namely higher output capacity that does not generate price pressure. The most credible driver is AI-driven productivity. If the Fed is correct and the economy can sustain 2.0% real growth at 2.0% inflation, the long-run disinflationary case has a structural foundation not yet visible in near-term data. This is the one genuine counterargument to a perpetually rising yield path, qualifying long-run conviction without altering the near-term view.

The breakeven chart shows a different near-term trajectory. The 10-year breakeven troughed near 2.21% in late 2025 when energy prices were contained and the Iran conflict had not yet disrupted supply. From that trough, breakevens rose steadily to trade near 2.45% by May 2026, driven by the Hormuz disruption and the subsequent oil shock running through transportation, manufacturing, and food costs. Breakevens are not unanchored and have not replicated the 2022 spike, but the trend is consistently upward. At these levels, the market is pricing inflation that persistently exceeds the Fed’s 2% target for the full decade ahead, signaling a structural shift.

The real yield chart shows the upside pressure as well. The 10-year TIPS yield sat near negative 1% in mid-2021 at peak Fed asset purchases. It crossed zero in early 2022, peaked near 2.4% in late 2023, and has since ranged between approximately 1.5% and 2.2%. It currently sits near 2.16%. The math is simple, a 2.16% real yield plus a 2.45% breakeven implies a nominal 10-year of approximately 4.61%, which is consistent with where the market is trading.

Real yields at 2.16% reflect a policy rate the FOMC has held restrictive through three consecutive meetings with zero easing probability priced for the remainder of 2026. Breakevens at 2.45% reflect inflation expectations that have moved steadily higher due to the reasons we have already discussed. Meaningful compression in the nominal 10-year requires at least one component to fall. Neither has a credible near-term catalyst absent a Hormuz resolution or a material deterioration in labor markets.

The case for structurally higher yields is laid out just by evaluating the data at hand. The oil shock lacks near-term resolution, the fiscal trajectory lacks political correction, and the foreign bid is quantifiably smaller than a decade ago. CME FedWatch assigns a 0% probability to 2026 easing alongside a 48.4% probability of a December hike.

The Equity Market Implications

The S&P 500 forward 12-month P/E stands at 21.2x, exceeding its 5-year average of 19.9x and 10-year average of 18.9x. At SPX 7,580, this multiple implies forward 12-month EPS of approximately $357, supported by actual Q1 2026 year-on-year earnings growth of 28.6% with an 85% beat rate, alongside a CY2026 consensus growth forecast of 22.6%.

Since early 2024, the 10-year Treasury yield has exceeded the S&P 500 earnings yield for the first time since the dot-com era. The current gap is 93 basis points, matching a trailing earnings yield of 3.68% against a 10-year yield of 4.61%. With the risk-free rate outpaying the equity market earnings yield, the allocation case rests exclusively on the growth premium. At 21.2x forward earnings, the index prices flawless execution, leaving zero margin for rate-driven multiple compression.

Historical yield spikes offer clear precedent. In 2022, a 275 basis point surge in the 10-year from 1.5% to 4.25% triggered a 25% peak-to-trough drawdown in the S&P 500. In October 2023, the 10-year touching 5.02% drove a 10.3% correction from the July high. In Q4 2018, a rapid 44 basis point move in six weeks caused a 19.8% drawdown. The impact across these episodes is determined by two variables: rate velocity and the multiple.

• Bull Case — SPX 8,200

  • An Iran ceasefire and Hormuz reopening drop Brent to $75–$80, compressing breakevens and pulling the 10-year yield down to 4.1%–4.2%. This allows the Fed to signal late-2026 cut optionality. As rates decline, the negative ERP closes and the risk-on trade resumes, supporting an S&P 500 multiple of 22x–23x on durable earnings. Applying a 23x forward P/E to the consensus $357 forward EPS yields an index target of 8,211, with energy deflation protecting corporate margins.

• Base Case — SPX 6,700

  • A prolonged oil shock grinding the 10-year yield to 5.0% forces institutional reallocation to fixed income via the negative ERP, compressing the S&P 500 multiple from 21.2x to 19.5x. Concurrently, rate headwinds trigger a 3.5% downward revision to consensus earnings, cutting forward EPS to $344. A 19.5x multiple on $344 EPS yields an index target of 6,708, reflecting a baseline under pressure rather than a full capitulation to the 10-year historical mean.

• Bear Case — SPX 5,900

  • If a failed auction or accelerated foreign liquidation triggers a disorderly spike in the 10-year Treasury yield to 5.25%–5.50%, credit spreads will widen as leveraged structures come under stress. A mild earnings recession follows as corporate capex freezes and consumer credit tightens, decelerating H2 2026 EPS growth to flat or negative. Applying an 18x forward P/E to a downwardly revised $328 forward EPS yields an index target of 5,904.

Earnings drive this market. Goldman Sachs projected 12% S&P 500 EPS growth for 2026 in January, citing AI-driven productivity as a structural tailwind, but actual Q1 results significantly outpaced that baseline. The question is not whether earnings support the index, but whether they can sustain the current multiple. With the risk-free rate exceeding the earnings yield and a 48.4% probability of a December hike, the valuation rests entirely on flawless execution.

Our Framework

The data assembled across this report requires no editorial interpretation. The 10-year nominal yield at 4.61% decomposes into a real yield of 2.16% and a breakeven of 2.45%, with no near-term catalyst visible for either to compress. Breakevens have climbed from 2.21% in late 2025 to 2.45% in May 2026, driven by an Iran shock that remains unresolved. CME FedWatch prices zero probability of 2026 easing and a 48.4% probability of a December hike. China’s Treasury holdings sit at an 18-year low. Japan net sold $29.6 billion in Q1 2026. The FY2026 deficit requires $166 billion in monthly issuance into an auction market showing widening tails and declining cover ratios.

Uncertainty across equity markets is elevated. Disciplined capital allocation means adhering to your risk parameters regardless of market noise, and in periods of genuine uncertainty, the decision not to trade is itself a position. We remain cautious on long-duration equities, high-multiple growth, and leveraged structures, monitoring those exposures for entry points that offer asymmetric risk-reward rather than forcing conviction where it does not exist. We favor names with durable earnings, genuine pricing power, and positive free cash flow. Defensive commodity and energy exposure is additive here, as these are sectors whose revenue profiles expand nominally under the same inflationary forces pressuring the long end of the curve.

The sole counterargument is the March SEP’s upward revision to longer-run GDP, suggesting AI-driven productivity has raised the non-inflationary growth ceiling. That structural case is measured in years. The energy shock, the fiscal arithmetic, and the auction data are measured in weeks.

Stay measured.

ZCR

Read my disclaimer here.

The International Energy Agency April 14 Oil Market Report deserves credit for its intellectual rigor. While most institutions are searching for language to describe this moment, the IEA called it plainly: the largest oil supply disruption in history. Global supply plummeted 10.1 million barrels per day in March to 97 million. By April, the floor drops to 94.2 million. Strait of Hormuz flows that ran above 20 million barrels per day in February are now averaging 3.8 million. Brent hit 130 dollars with spot markets touching 150 dollars, roughly 60 dollars above pre conflict levels in six weeks. The 400 million barrel reserve release buys time, not resolution.

The IEA presents two paths for the current energy landscape. In the base case, shipments gradually resume from May with a deficit peak in June. In the protracted case, a 6 million barrel per day deficit persists through December, draining nearly 2 billion barrels of global stocks.

As of April 18, Iran has reimposed strict control over the Strait after briefly signaling an opening. IRGC gunboats have opened fire on vessels transiting the waterway, and a second round of United States and Iran negotiations is tentatively scheduled for Monday in Pakistan with no confirmed agreement from either side. We will have to see how this weekend events unfold however the framework of the protracted case may eventually be our new reality.

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Historical Precedent: Duration is the Variable

Four major shocks provide the data we need to think clearly:

• 1973 Arab Embargo: OPEC removed 4.5 million barrels. Prices quadrupled and the S&P 500 fell more than 40 percent. Real disposable personal income was crushed as energy costs consumed 14 percent of household budgets.

• 1979 Iranian Revolution: Exports collapsed and prices doubled. The S&P 500 held initially, but the Federal Reserve response, driving rates to 20 percent, triggered a brutal bear market in 1981 to 1982. The lesson is that the policy response often does more damage than the shock itself.

• 1990 Gulf War: 4.3 million barrels were removed. Oil surged 75 percent and the S&P 500 fell 20 percent. The shock was absorbed quickly due to a decisive coalition response and a short conflict. This is the soft landing precedent.

• 2008 Financial Crisis: A demand driven spike to 147 dollars. The S&P 500 fell 57 percent as industrials and transportation margins contracted 300 to 500 basis points.

In every supply driven crisis between 1973 and 1991, the S&P 500 experienced declines of 20 to 48 percent. History draws a sharp line between shocks that became recessions and those that did not. The variable that determined which side of that line each episode fell on was always the same thing: how long the disruption lasted.

The Macro Transmission Channels

Energy shocks do not hit the economy in a linear sequence. They operate through six simultaneous channels that compound the initial disruption.

1. Inflation and the Fed Response

   1. Gasoline and diesel prices typically pass through to the broader CPI within 60 to 90 days. With US gasoline already up 31 percent, price acceleration is the primary risk facing the consumer. The Fed is effectively paralyzed by this sticky inflation, as Powell has signaled that rate cuts are off the table until price growth resumes its downward trajectory and macro uncertainty subsides. This policy rigidity creates a definitive ceiling on market multiples, as the cost of capital remains elevated despite cooling growth.

2. Household Balance Sheets

   1. We are entering this shock with lower income households already allocating 60 percent of their budgets to essentials. Unlike prior cycles where accumulated savings provided a necessary cushion, the current household buffer is largely depleted before the energy shock has even fully arrived at the pump. This lack of financial elasticity means any further increase in energy costs will directly force a reduction in discretionary consumption.

3. Real Disposable Personal Income

   1. With savings rates at lows and credit card delinquencies reaching 14 year peaks, the consumer is uniquely vulnerable. In past multi year shocks, real income contracted significantly as nominal wage growth failed to keep pace with the energy led inflation surge. This divergence suggests that the current household remains poorly positioned to absorb sustained price increases without a meaningful reduction in standard of living.

4. Unemployment

   1. The labor market remains a lagging indicator. Historically, the average duration between the onset of a shock and peak unemployment is 18 to 24 months. While current data indicates hiring freezes and a wait and see posture, the true impact on the labor market will likely not be fully realized until late 2027. This lag suggests that current employment strength may offer a false sense of security regarding the underlying health of the economy.

5. Margin Compression

   1. This remains the most direct transmission to the equity markets. When energy input costs rise faster than pricing power allows, margins compress and earnings estimates fall. Historically, the 1973 shock caused S&P 500 earnings to drop 15 percent, while the 1990 event triggered a 12 percent decline. Transportation, industrials, and staples are hit first and hardest as multiples reprice to reflect lower forward earnings. The inability to pass through costs in these sectors often serves as the lead indicator for a broader earnings recession.

6. CapEx

   1. Uncertainty at this magnitude causes capital expenditure and hiring to seize up. Companies defer projects, creating a secondary drag on GDP that compounds consumer side pressure. As the ISM new orders subindex continues to fall, the uncertainty channel operates faster than unemployment, acting as a lead indicator for broader economic stagnation. This freeze in business investment often creates a self fulfilling cycle that accelerates the transition from a sector specific shock to a systemic recession.

Our Playbook: Clarity in the Fog

The situation remains fluid. If this resolves like 1990, a two to three month shock produces a 20 percent drawdown that is recoverable. If it extends like 1979, the second order effects of the policy response become the primary risk.

Our roadmap stays defensive: high liquidity, derivative hedges, and patience. We are simultaneously identifying quality businesses with pricing power being dragged down by the noise. We do not time bottoms. We focus on establishing whether a business is trading at a meaningful discount to intrinsic value. Corrections separate the names worth owning from those merely riding the cycle.

Stay measured. Do the work. The fog will eventually lift.

Read my disclaimer here.

ZCR