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by Stu Caplan on Aug 17, 2026
If inflation is cooling, why aren't interest rates falling faster?
The simple answer is that inflation is only one ingredient in a bond yield.
Take the 10-year Treasury. Investors aren't just making a bet on what inflation will be next month or what the Fed does at its next meeting. They're committing money for a decade. The yield they demand reflects expectations for inflation and Fed policy, but also economic growth, government borrowing, Treasury supply, and the additional compensation investors require for taking long-term interest-rate risk.
For much of the post-financial-crisis era, investors didn't demand much of a premium to own long-term Treasuries. Inflation was low, the Fed was a major buyer of bonds, fiscal deficits were generally smaller, and there was a widespread belief that rates would remain low for a very long time.
That world has changed.
Inflation has moderated, but it remains above the Fed's 2% objective. The Fed's July 2026 statement continued to characterize inflation as elevated, and three FOMC members voted to raise rates by another quarter point.
Going from 6% inflation to 3% is meaningful progress. Going from 3% to 2% may prove considerably harder. The bond market must price the possibility that inflation settles somewhat above the Fed's target or simply remains more volatile than it was during the 2010s. Even if the Fed eventually cuts short-term rates, that doesn't automatically mean the 10-year Treasury follows it lower.
In fact, Federal Reserve research published earlier this year specifically examined why long-term Treasury rates have remained elevated. The researchers noted that the 10-year Treasury had remained above 4% despite 175 basis points of Fed cuts over the preceding year and a half. Interestingly, their work suggests the move has been driven less by rising long-term inflation expectations and more by investors demanding a higher risk premium. Concerns about future deficits, Treasury supply, and the possibility of economic shocks all appear to be part of that repricing.
Then there is the fiscal side of the equation.
The federal government continues to borrow significant amounts of money. Treasury estimated that it would need $671 billion of privately held net marketable borrowing during the July through September quarter alone.
That matters because Treasuries are ultimately a market like anything else. More supply needs to find a buyer, and price matters.
If investors are being asked to absorb increasingly large amounts of Treasury debt, they may demand a higher yield to do it. This doesn't mean the United States can't finance its deficits. That's not the argument. The question is simply: at what price?
For years, investors didn't need much convincing to own long-term government bonds yielding 2% or 3%. Today, with inflation uncertainty higher and enormous amounts of government debt coming to market, buyers may reasonably demand more compensation. That helps explain why longer-term yields can remain elevated even while inflation improves.
There's another misconception worth clearing up. The Fed controls the overnight federal funds rate. It does not set the 10-year Treasury yield.
The Fed can influence longer-term rates through policy expectations and its balance sheet, but ultimately those securities trade in a global market.
Interestingly, the Fed has been purchasing shorter-term Treasury bills in 2026 as part of its reserve-management operations, rather than conducting the kind of broad long-duration quantitative easing we became accustomed to after the financial crisis and during COVID. The Fed reported that its Treasury holdings had increased by roughly $257 billion from early January through July 1, with much of the activity concentrated in short-term Treasury bills.
A Fed that maintains adequate banking-system reserves by buying bills is very different from a Fed deliberately suppressing long-term yields through massive purchases of 10- and 30-year bonds.
The private market is being asked to do more of the price discovery farther out on the curve, and right now, that market seems to be saying: if you want me to lend you money for 10 or 30 years, I want to be paid.
There's also a bigger question worth asking. Maybe we're still anchored to the wrong definition of normal.
Investors spent roughly 15 years getting accustomed to extraordinarily low interest rates. A 10-year Treasury yielding 4% or 4.5% now feels high largely because we're comparing it with a period when rates were held unusually low by a combination of zero-interest-rate policy, quantitative easing, low inflation, and enormous demand for safe assets.
Historically, today's yields aren't particularly extraordinary. Maybe the anomaly wasn't today's 4%-plus 10-year Treasury. Maybe the anomaly was a 10-year Treasury yielding 1.5%. If inflation ultimately settles somewhere near 2%, economic growth remains reasonable, the government continues running substantial deficits, and investors once again demand a real return for locking up money for a decade, there is no rule saying the 10-year Treasury needs to return to 2% or 3%.
I can see a scenario where the Fed eventually brings short-term rates lower as inflation continues to improve, but I don't necessarily see the same gravitational pull on the long end. Short rates could fall because of Fed cuts while long rates remain relatively sticky because investors still demand compensation for economic uncertainty, fiscal deficits, Treasury supply, and duration risk.
Put those together and you get a steeper yield curve, and this may be the message the bond market is trying to send us today.
From an investment standpoint, I think that creates an interesting setup. Short and intermediate-term bonds continue to offer attractive yields without requiring investors to take significant duration risk. If the Fed eventually cuts, those yields may not be available forever. At the same time, I am not convinced investors need to reach aggressively into long-duration bonds simply because inflation is cooling.
For me, that is the opportunity in fixed income today. You don't have to make a heroic call on where the 10-year Treasury is headed. You can get paid to wait, maintain flexibility, and extend duration selectively when the risk and reward make sense.
The bond market isn't telling us that rates are headed higher or lower. However, it may be telling us that the old relationship between inflation, Fed policy, and long-term yields may be changing, making today’s bond market worthy of our attention.
Sources:
https://www.federalreserve.gov/newsevents/pressreleases/monetary20260729a.htm
https://home.treasury.gov/news/press-releases/sb0485
https://www.federalreserve.gov/monetarypolicy/2026-07-mpr-part2.htm
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About the Author – Stu Caplan, CFP®
Stu Caplan is Senior Wealth Strategist at Members’ Wealth, a boutique wealth management firm that offers a comprehensive approach to serving individuals, families, business owners, and institutions.
The firm’s goal is to preserve and grow its clients’ wealth to endure over time, while thoughtfully evolving its strategy to suit an ever-changing world. With over 20 years of industry experience, Stu and the Members' Wealth team thrive on bringing clarity and confidence to clients' unique situations.
Stu received his MBA from The Robert H. Smith School of Business at the University of Maryland and his bachelor’s degree from the Eller College of Management at the University of Arizona. Stu resides in Bucks County, PA with his wife and two sons. He’s an avid golfer and is thrilled that his boys have embraced the game. He also volunteers his time as a board member of the PKD Foundation and Abrams Hebrew Academy.
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