Even in a shortened trading week, markets can absorb a remarkable amount of information. Recent sessions have delivered a confusing blend of softening growth signals and more hawkish central bank rhetoric — a combination that invites the dreaded word "stagflation." Yet the most useful framing may be "stagflation with a small s": a reminder that the term has two distinct components, and only one of them is genuinely threatening right now.
The Growth Side Is Holding Up
Stagflation, properly understood, requires both stagnant growth and rising inflation. On the growth side, the evidence simply does not support alarm. The most recent GDP report showed only slight downward revisions, with a modest downward revision to personal consumption. For the most part, the economy continues to expand close to its 2% trend rate, give or take from quarter to quarter. The "stag" in stagflation, in other words, does not appear to be much of a problem. The economy looks okay for now.
That is why skepticism is warranted whenever commentators reach for the stagflation label. The diagnosis only half applies. The real story — and where attention genuinely belongs — is on inflation.
All Eyes on Inflation
The latest PCE release confirmed what most observers expected: inflation is moving in the wrong direction, driven largely by the rising price of oil and gas. The pressing question is whether this is sustainable. Oil prices have actually eased somewhat over the past week and have been holding within a range, with crude trading below $90 a barrel and down roughly 10% week to date. If prices stabilize, the punishing month-over-month increases could begin to moderate.
Much depends on geopolitics. The duration of the conflict between the United States and Iran, and whether it gives way to genuine de-escalation — perhaps some form of 60-day truce — would generally be good news for the inflation outlook. But there is a deeper worry. Inflation has now run above the Federal Reserve's 2% target for more than five years, regardless of which indicator you examine. A single bout of cheaper oil is not going to flip the script and send inflation sharply lower. We appear to have settled into an environment where inflation is likely to remain somewhat elevated and, more importantly, somewhat unpredictable. It is the uncertainty around the path of inflation, as much as its level, that defines the moment.
The Puzzle of Elevated Yields
This inflation backdrop helps explain an otherwise puzzling feature of the bond market. Even with crude falling, the 10-year Treasury yield sits around 4.45% — off the highs of recent weeks, but still toward the upper end of its range over the past several months. Why should yields remain stubbornly high while oil retreats?
The answer is not really about skepticism toward the conflict. Even a hopeful scenario in which tensions cool does not, by itself, justify a sharp decline in long-term yields. That has been the base case for months. There is no shortage of forces capable of keeping long-term yields elevated: inflation remains high, and fiscal concerns are not going to disappear anytime soon.
There is also the matter of what foreign governments are doing. Japan's recent disclosure that it spent roughly $73 billion in a single month to prop up the yen is a vivid reminder that currency interventions abroad ripple directly into the market for U.S. Treasuries. These cross-border dynamics add yet another layer of complexity to the yield picture.
A New Monetary Regime
The most compelling explanation, however, points to a structural shift — a possible new regime. With inflation firmly present and its trajectory uncertain, investors may simply demand higher yields at the long end of the curve to compensate for that uncertainty.
Consider the contrast with the past fifteen years. During the long stretch of ultra-low interest rates and subdued inflation, the Federal Reserve leaned heavily on its balance sheet, actively suppressing yields while inflation stayed quiet. That era of using the balance sheet as a primary monetary policy tool is probably behind us, particularly under a new Fed chair in Kevin Warsh. The implication is striking: even if economic data eventually builds the case for rate cuts down the road — not this year, which looks unlikely — long-term yields may not follow obediently lower. Investors could continue to demand a higher premium precisely because inflation uncertainty refuses to fade. The term premium embedded in 10-year yields may stay higher for longer.
Positioning for the Environment
These convictions translate directly into how one should think about fixed income. The prudent stance is a duration slightly below the benchmark average — but, crucially, that does not mean retreating entirely into cash.
The yield curve is currently positively sloped. It is not steep, but as you move out from Treasury bills to two-year, five-year, and ten-year maturities, you are rewarded with marginally higher yields. That makes a strong case against simply parking money in cash, which carries a real opportunity cost. Short- and intermediate-term bonds — two-, three-, and five-year Treasuries — offer better yields without exposing a portfolio to undue risk.
Extending duration aggressively, by contrast, is hard to justify right now. With more risks tilted to the upside than the downside for long-term yields, going long invites the danger that bond values fall if yields climb further. The judgment is that there is little missed opportunity in waiting. Staying modestly below benchmark duration is the better way to manage interest-rate risk while still capturing the yields available further along a positively sloped curve.
It is worth noting how minor some of the technical signals being debated really are. There has been chatter about a minuscule inversion of one to two basis points in market pricing for the Fed funds rate around the one-and-a-half-to-two-year horizon — an inversion so small that it takes a microscope to detect, amounting to less than a handful of Skittles. The more meaningful structural feature is the positively sloped curve and the rewards it offers for moving out of cash.
What Comes Next
The week ahead is a busy one for data. The ISM surveys, covering both manufacturing and services, will arrive, but the single most important release is Friday's jobs report. For now, the labor market is taking a backseat to inflation in shaping Fed policy, yet a clear shift in trend in either direction would change that calculus quickly.
At present the labor market looks stable. The unemployment rate ticked up from the lows of 2021 and 2022, but not sharply, and over nearly two years it has held within a tight band between 4% and 4.5%, currently sitting around 4.3%. The base case is continued stability. But the policy implications cut in interesting directions. If unemployment were to rise, committee members might grow concerned about the drag from higher gas prices on discretionary spending — a development that could forestall rate hikes. Conversely, if the labor market strengthens while inflation remains high, and policymakers conclude the economy can withstand tighter policy, the odds of a rate hike could actually increase.
This is the heart of the matter. The economy is not stagnating, but inflation is proving sticky and, above all, uncertain. In a world where the central bank no longer suppresses yields through its balance sheet, that uncertainty carries a price — and investors are likely to keep demanding it at the long end of the curve.