Have Inflation Fears Really Returned? Gold and the Message of Inflation Expectations

MarketWatch published an article on gold that was later reprinted in Morningstar news, where I came across it. Among other things, the article stated the following:

“The yellow metal has gotten hammered this month as oil prices have spiked and inflation fears have roared back, while technology stocks and even bitcoin - the very bets investors are supposed to flee in a panic - have ripped higher and helped underpin the broader stock market.”

I would like to address the "inflation fears" comment because the data from the past year do not fully support that characterization. Let me show you four charts obtained from the St. Louis FED Fred tool.

1. Monetary Base, which accounts for currency in circulation plus reserve balances. This is a proxy of how much liquidity the FRB has pumped into the financial system. Note: Red arrows are my notation.

Let's examine the increase in the monetary base between November 2025 and May 2026. During that period, the monetary base increased approximately 4.5% (=(160.9/154) - 1)*100), but then it declined to about 2.3% from May 2026 to August 2026. 

2. Median Consumer Price Index, which “according to research from the Cleveland Fed, the Median CPI provides a better signal of the inflation trend than either the all-items CPI or the CPI excluding food and energy. According to newer research done at the Cleveland Fed, the Median CPI is even better at PCE inflation in the near and longer term than the core PCE.” Note: Red arrows are my notation.

3. 3-Year Expected Inflation, which is a Cleveland Fed measure of expected inflation derived from Treasury yields, inflation swaps, inflation data, and survey-based measures of inflation expectations.

4. 5-Year Breakeven Inflation Rate, which “represents a measure of expected inflation derived from 5-Year Treasury Constant Maturity Securities (DGS5) and 5-Year Treasury Inflation-Indexed Constant Maturity Securities. The latest value implies what market participants expect inflation to be in the next 5 years, on average.”

Charts 2 through 4 suggest that inflation expectations remain relatively well anchored alongside current inflation measures. If inflation fears were becoming widespread and persistent, we would likely expect to see a more significant increase in both realized inflation measures and inflation expectations.

Conclusion:

Gold is a political hedge and an inflation hedge. Currently, there is little evidence of broad-based accelerating inflation, nor do inflation expectations suggest such an outcome in the near term. In the political sphere, the behavior of gold prices suggests that investors may not currently be pricing a major and lasting economic disruption from the conflict.

Opportunity Cost of Illiquidity: Why Flexibility Has Value

At a conference today, I heard a term that immediately caught my attention. I must confess that I had never heard the phrase before, but it definitely resonated with me and left me thinking more deeply about its meaning and significance.

Let us define some terms first.

What is ‘opportunity cost’? It is the value of the next best alternative that we forgo when choosing one option over another. For example, the opportunity cost of investing capital in equities may be the interest income that could have been earned from a government security.

What is ‘illiquidity’? To answer that fully, we must look first at the definition of liquidity. Liquidity is the ability to turn some asset into cash quickly and without a high cost. Therefore, illiquidity means either the inability to convert an asset into cash quickly or the need to incur a significant cost in order to do so.

Putting this all together, the opportunity cost of illiquidity is the value of the opportunities that become unavailable because capital is locked in an asset that cannot be easily converted into cash.

The individual who mentioned the phrase said that investors either underestimate the ‘opportunity cost of illiquidity’ or ignore it altogether. Although the speaker did not elaborate further, I took his phrase to mean that, as investors, we must consider not only the investment we are about to make but also the alternative opportunities that may become unavailable once our capital is committed. In other words, many investors focus on the question, “What return will I earn from this investment?” but the real question should be, “What flexibility am I giving up by making this investment?”

When we talk about flexibility, we are in fact talking about optionality, which means the ability to react to crises, exploit opportunities, rebalance, or meet unforeseen obligations. Liquidity has value because it preserves future choices, and the opportunity cost of illiquidity is the loss of that optionality. An illiquid investment may earn 12%, but if that investment prevents you from deploying capital into an extraordinary 30% opportunity later, the true economic cost may be much greater than initially expected.

Conclusion:

Liquidity is more than a source of funding. It is a reserve of future possibilities. The opportunity cost of illiquidity, therefore, is not merely the inability to access cash, but the loss of opportunities that may arise while our capital remains locked away. This may help explain why experienced investors often maintain cash reserves even when attractive investments are available. The value of liquidity is not always apparent today, but it becomes obvious when unexpected opportunities emerge. Illiquidity does not need to have a negative connotation, but an adept investor may willingly surrender liquidity if he is being adequately compensated.

This concept applies not only to investing, but also to life in general. For example, taking a highly specialized job may create opportunity costs by reducing future career flexibility; or purchasing a home versus renting can involve an opportunity cost of reduced mobility. In that sense, liquidity and optionality are not merely financial concepts. They are frameworks for decision-making under uncertainty.

How Interest Rate Changes Affect Bank Profitability and Capital

Interest Rate Risk in the Banking Book (IRRBB) refers to the potential impact that changes in market interest rates can have on a bank's earnings and its overall capital. This risk arises from the core business of banking: taking in deposits and lending money out, often over different timeframes and at different types of rates (fixed vs floating).

We can break down the main effects into three key areas:

1. The Funding Side: The Cost of Deposits

A bank's primary source of funding is customer deposits. The risk here is that the cost of these deposits can change unexpectedly. When market interest rates rise, banks may need to increase the interest they pay to depositors to prevent customers from moving their money to higher-yielding investments. If the bank has to raise its deposit rate quickly, its cost of funding goes up, which squeezes the profit margin it earns from lending. Conversely, when rates fall, if the bank cannot lower its deposit rates proportionally (perhaps because they are already near zero), its profit margin is also compressed.

2. The Asset Side: The value of Loans and Mortgages

This is the risk associated with the money the bank has already lent out, especially long-term, fixed-rate loans like mortgages. Consider this example: If a bank has issued a 30-year mortgage at a fixed rate of 3%, and market rates then rise to 5%, the bank is stuck earning a below-market rate for years. The economic value of that 3% loan decreases because it's less profitable than a new loan issued today. We refer to this economic relationship as 'duration' risk.

If market rates fall significantly, homeowners with those 3% mortgages will likely refinance to get a new, lower rate. They pay back their loans to the bank early. The bank now has its cash back, but must lend it out again at the new, lower market rate, earning less income than it had originally planned. This is known as Prepayment Risk.

3. The Impact on Capital: The Investment Portfolio

This is a direct and significant impact on the bank’s balance sheet and net worth, separate from its day-to-day earnings. Banks hold large portfolios of high quality securities (like government treasuries) as a way to store liquidity. When interest rates rise, the market value of existing, lower-yielding bonds falls. There is a negative relationship between market interest rates and the price of fixed-income securities. This “paper loss” doesn’t immediately hit the bank’s income statement. Instead, it is recorded in a special section of shareholder’s equity called Accumulated Other Comprehensive Income (AOCI). A negative entry in AOCI directly reduces the bank’s total equity, thereby lowering its book value and shrinking its capital base.  

Putting the Pieces Together

Let me give you a brief example. Take a look at the interest income and interest expense behavior based on data available in the St. Louis FED FRED Tool.

It is clear that around 2Q2022 to about 3Q2024 interest expense increased faster than interest income, leading to a compression in bank’s net interest income. This particular time was when we had higher market interest rates. 

Conclusion:

Interest rate risk can materially affect a bank's earnings, liquidity profile, and capital position. Depending on the structure of its assets and liabilities, rising interest rates may initially benefit or hurt net interest income. However, as funding costs adjust and securities portfolios experience valuation pressure, many banks face net interest income margin compression and reductions in economic capital. While banks actively hedge these exposures, hedging involves costs and may not fully offset the effects of large interest rate movements.

The Art of Plausible Deniability in Market Commentary

I recently read an opinion piece in the Financial Times arguing that 5% is the "magic number" for the U.S. 10-year Treasury yield and that yields are unlikely to move sustainably higher. The writer is Karen Ward, who is the chief market strategist for Europe, Middle East and Africa at JPMorgan Asset Management.

Karen framed the discussion around three arguments for higher yields:

1. AI-driven productivity gains have raised the neutral rate of interest.

2. Investors should demand a larger premium because of deteriorating U.S. fiscal policy.

3. Bonds have lost their diversification benefits.

What struck me was that the author treated these three arguments very differently.

For the first argument, she discussed why AI productivity gains would need to be exceptionally large to justify materially higher yields and pointed to signs that higher rates are already affecting the economy. However, she never clearly stated, "I am skeptical of this view." The reader is left to infer her position.

The second argument was similar. She acknowledged that U.S. fiscal policy likely deserves some additional risk premium, but then emphasized the Federal Reserve's credibility in controlling inflation. Again, she never directly stated whether she believed fiscal concerns were large enough to drive yields materially higher. Here again, we are left to wonder what her stance is.

The third argument was different. There, the author explicitly stated, "This is wrong." She rejected the idea that bonds have permanently lost their diversification value, arguing that if the AI boom weakens and growth slows, Treasuries could still provide significant portfolio protection through falling yields and Fed rate cuts. To me, there is nothing particularly revelatory about her observation because that is largely what has transpired in recent years, although I would argue that this view rests on shakier foundations than many investors assume.  

Let’s go back to her points. Note the asymmetry in treatment for each one. Given that the author is a chief strategist at a large asset manager, this may not be accidental. Institutional market commentary often leaves room for multiple outcomes. Strongly rejecting an argument can be costly if events later prove otherwise.

The important takeaway of Karen's view is that it's broadly representative of the prevailing Wall Street narrative that yields are approaching a ceiling and are unlikely to move sustainably higher. However, it largely dismisses the fact that Treasury yields have been on a sustained upward trajectory since 2020. In April 2020, the 10-year Treasury yield was roughly 0.61%, and by September 24, 2026, it had risen to 5.18%. I do not yet see evidence that the forces driving higher yields have gone away.

Conclusion:

Beware when reading market views of institutional players because incentives may be misaligned. That does not mean that the analysis is wrong, but incentives are a big deal to determine credibility. When a strategist at a major institution publishes an opinion piece, from their perspective there is often value (incentives) in leaving room for multiple outcomes.

As an independent observer, my incentives are gaining wisdom, knowledge, and understanding and conveying what I see to the broader public. Unlike institutional strategists, I am not tasked with representing a large asset-management business.

There is nothing magical about 5%, or 4.99%, or 6%. People (or the markets) give meaning to those numbers. What matters is the trend. As I've pointed out previously, the upward trend in yields remains firmly entrenched. Given the amount of liquidity and fiscal spending in the system, I believe it will become increasingly difficult for the FOMC to prevent bond vigilantes from demanding higher yields.

Record Emerging Market Debt Issuance: Opportunity or Warning Sign?

Emerging markets have issued a record amount of foreign-currency debt this year despite higher global interest rates and a stronger U.S. dollar. Is this a sign of confidence, or are investors overlooking risks that have repeatedly surfaced throughout history?

My latest note explores some drivers behind the issuance boom and the lessons from past emerging market debt crises:

https://uncommoninsight384054130.wordpress.com/2026/09/24/not-all-is-well-a-tale-of-emerging-market-debt/

Surging government bond yields raise alarm

The era of ultra-low interest rates is over, but global debt continues to grow. With G7 bond yields at their highest levels since 2008 and debt-servicing costs climbing, policymakers and investors are increasingly worried about sustainability. 

Read my brief note on one of the most important macroeconomic challenges facing the world today:

https://uncommoninsight384054130.wordpress.com/2026/09/24/surging-government-bond-yields-raise-alarm/

Late‑Cycle Financial Engineering: Are CFOs and NAV Loans the Canary in the Coal Mine?

The Financial Times just highlighted the surge in CFOs and NAV loans, two complex instruments that echo the financial engineering we saw before 2008. These markets have grown several‑fold since 2021, despite being opaque and difficult to price. To me, they signal that we’re deep into the late stages of this financial cycle.

I break down the data, the risks, and the historical parallels on my WordPress blog here:

https://uncommoninsight384054130.wordpress.com/2026/09/23/late-cycle-financial-engineering-are-cfos-and-nav-loans-the-canary-in-the-coal-mine/ 

Inflation 101 – What is it?

Inflation is not “prices going up.” That is the symptom. The cause is far simpler: when money supply outruns the real economy, everything else follows. The data from 2016–2026 makes this impossible to ignore.

Go to my WordPress site to read the full post here:

https://uncommoninsight384054130.wordpress.com/2026/09/22/inflation-101-what-is-it/

Economic Risk Dashboard: A Framework to View the US Economy

This post introduces a practical dashboard for assessing the health of the US economy amid an age of deep uncertainty. By monitoring foundational indicators across household strength, credit markets, and consumer confidence, the framework offers a structured way to interpret where we may be in the economic cycle. Yet the analysis also acknowledges a critical truth: numerical metrics, while useful, are judgmental representations of reality. They cannot replace wisdom, knowledge, and understanding, which require a deeper philosophical view of how economic life actually works.

Go to my WordPress site to read the full post here:

https://uncommoninsight384054130.wordpress.com/2026/09/19/economic-risk-dashboard-a-framework-to-view-the-us-economy/

Housing Prices and Mortgage Rates – Where Do We Go From Here?

I was curious to see what has been the relationship of house prices and mortgage rates over the last decade, starting in February 2026. I went to the St. Louis Fed Fred tool to observe the relationship between the S&P Cotality Case-Shiller U.S. National Home Price Index and the 30-Year Fixed Rate Mortgage Average in the United States. To clearly see the movement, I rebased both metrics to the same date and year (February 2016) to compare their levels.

As can be seen in the graph below, home prices rose dramatically and steadily from 2016 through 2022, while mortgage rates stayed low and stable; but once mortgage rates spiked in 2022, home‑price growth flattened sharply, showing that the affordability shock effectively halted further appreciation even though prices did not fall.

        Source: https://fred.stlouisfed.org/graph/?g=1YL3Q

The divergence between the two lines, i.e., mortgage rates rising sharply while home prices remain elevated, captures the core dynamic of the current housing market: demand is constrained by financing costs, but supply remains too tight for prices to correct meaningfully.

If mortgage rates continue to rise from here, three broad scenarios emerge in my view:

Scenario 1: A modest rate increase leads to a national flat‑line in home prices, with only regional declines.

Scenario 2: A sharper rate increase produces mild national price declines as affordability deteriorates further.

Scenario 3: Rising rates combine with rising unemployment, creating an environment where meaningful nationwide price declines occur.

I am forecasting a recession in the next 6 to 12 months. Because of that I believe that the economy will eventually reach this third scenario, but without a repeat of the 2008–2010 housing crisis, because today’s market lacks the extreme leverage, speculative inventory, and credit‑quality deterioration that defined that period.

September 2026: What the Federal Reserve Thinks About the Broader Economy

Here is a graph courtesy of the Financial Times that shows what the member of the Federal Reserve who vote on interest rates think about the broader economy.

A few things stand out:

• Most officials cluster around the 4% range for 2026 and 2027. This means that there is broad consensus that rates will not fall quickly and it is the Fed’s way of quietly signaling that the era of 0 to 2% rates is over.

• The longer-run dots are creeping upward, sitting mostly above 3%. This implies that the Fed believes the economy can sustain higher rates without a recession.

• Core PCE inflation expectations for 2026 have risen, which means that Fed officials believe inflation will be more persistent than previously thought. The Fed here is signaling to expect a slower return to their prefer target of 2%. The 2027 inflation line is flatter, meaning that Fed officials think inflation will eventually ease, but gradually.

• The GDP line shows that Fed officials believe growth is expected to be modest, but stable. And the unemployment line staying near 4% tells us that the Fed thinks that the labor market will remain tight.

Putting this all together, the charts show that Fed officials expect interest rates to stay higher for longer, inflation to be stickier than previously assumed, GDP growth to remain modest, and unemployment to stay low. The combination signals a central bank that sees persistent inflation pressures and no imminent recession, which is why the rate path is flatter (i.e., no sharp cuts expected) and elevated (the longer‑run neutral rate drifting above its historical 2–2.5% range).

Inflation Fears: The Reason Why Interest Rates are Climbing Now

In an article published today (September 14, 2026) by the Financial Times we read that the 10-year US Treasury Bond reached 5% during the trading session. “The yield rose 0.04 percentage points to hit a high of 5.01 per cent in morning trading on Wall Street, before easing back to 4.98 per cent.” As can be seen from the graph below, the yields have hit a peak not seen since 2023 and prior to that you have to go back to the Great Financial Crisis period to see such a rate:

              Source: Financial Times
 

A Quick Primer on Nominal Interest Rates

Nominal interest rates are driven by inflation expectations and a term premium. Nominal rates start with the real interest rate, which is driven by economic growth, demand and supply of loanable funds, etc. The market then adds an inflation expectation percentage amount and a term premium amount to the real interest rate to come up with the nominal interest rates we see reported. Inflation expectations have to do with average expected inflation over the time horizon of the fixed income instrument. Term premium includes an additional element to account for the fact that the inflation expectation can be wrong. In other words, inflation expectation has to do with mean (average) expectation and term premium includes some percentage amount to account for the variance deviation of that expectation.  

Inflation Up Interest Rate Up

Let’s take a look at a metric that gives us a glimpse of inflation expectation. Below you’ll see the 5-year forward inflation expectation rate, which is a metric that the Federal Reserve Board monitors as part of their dataset to determine monetary policy.

        Source: Federal Reserve Bank of St. Louis, 5-Year, 5-Year Forward Inflation Expectation Rate [T5YIFR], retrieved from FRED, Federal Reserve Bank of St.                Louis; https://fred.stlouisfed.org/series/T5YIFR, September 14, 2026.
 

You can clearly see the upward trend in inflation expectation being driven by oil price spikes resulting from the Iran War.

Making matters a bit more concerning is that the longer the elevated oil prices are maintained it will inevitably disrupt the term premium element of inflation and hence pushing upward pressure in nominal interest rates. That will have knock-on effects impacting economic growth expectations, fiscal deficits, and total government debt. Against this background, it would not be at all surprising if the Federal Reserve Open Market Committee (FOMC) decides to increase its target federal funds rate this coming week (to be announced on Wednesday, September 16).

September 2026 Equity Valuations: Above Trend and Beyond Normal Bounds

Let’s look at the broad level graph of the monthly close for the Dow Jones Industrial Average over the last 10 years (as of September 11, 2026), as reported by MarketWatch.

Starting from the low observed on March 1, 2020, the DJIA stood at 21,917. The most recent value for DJIA as of September 11, 2026 is 52,573. The total return during this time is 140%, and if we were to annualize the return, you are looking at a rate of 18.6% (you calculate it by dividing the most current value by the previous value, and then raise the result to 1 divided by time in years, and then you subtract 1 from that result, and then you convert to percentage by multiplying by 100).

Doing the same for the S&P 500, we observed a similar elevated return profile.

Starting from the low observed on March 1, 2020, the DJIA stood at 2,584. The most recent value for DJIA as of September 11, 2026 is 7,656. The total return during this time is 196%, and if we were to annualize the return, you are looking at a rate of 20%. This is almost double the historical standard over the last 50 years. I intentionally anchored the analysis at the March 2020 COVID low because it captures the full effect of the fiscal and monetary interventions that reshaped the post‑pandemic market environment. While this starting point inflates returns relative to neutral baselines, it is appropriate for evaluating the consequences of policy actions on equity valuations.

If the S&P 500 had grown at its historical long-term rate of approximately 12%, the index would be around 4,600 today (=(1.12^6.534)*2,584). In other words, the S&P 500 is about 66% (=(7,656 – 4,600)/4,600) above where long-term historical compounding would place it. All this indicates that we are in bubble territory. The question then is not if there will be a reversion to the mean, but rather how that will manifest.

A word of caution is warranted: As J.M. Keynes stated, “markets can remain irrational longer than you can remain solvent.” Although we cannot pin-point the exact day that the mean reversion will occur, I do believe we can know the season (i.e. time range) when that will happen. We will explore that in a future post.