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The bond market is shouting that money is getting expensive. But New York Fed President John Williams hears a different message in the rising Treasury yields.
In a CNBC interview on Wednesday, Williams said the climb in long-term yields is driven largely by a "strong U.S. economy and a strong economic outlook fueled by big investments," pointing to artificial intelligence, data centers, and technology spending broadly.
Williams told CNBC that the recent move is occurring mainly through higher real interest rates rather than inflation compensation.
"I see this as more of a reflection of the strength of the economy," Williams said.
Real rates measure the return investors receive after accounting for expected inflation. Their rise suggests investors are demanding higher compensation to finance an economy with increasing investment demand.
That is particularly relevant to the artificial intelligence boom.
Companies are spending enormous amounts on data centers, chips, and other infrastructure. The stronger that investment cycle becomes, the greater the demand for financing.
"I think it's not really about financial conditions affecting the economy. It's more about the economy affecting financial conditions," he said.
If higher yields are a symptom of investment demand rather than a brake on it, they do not tighten conditions on the central bank's behalf. This removes the strongest argument against a rate increase this month.
The 10-year Treasury yield held near 4.80% after touching 4.81%, its highest since October 2023. The 30-year sits at 5.28% and the two-year at 4.40%.
Traders now put roughly two-thirds odds on a 25-basis-point hike at the Sept. 16 meeting, up from about 40% a week ago, after Chair Kevin Warsh used his Jackson Hole debut to commit to bringing inflation down.
Williams acknowledged a correlation between higher oil prices and rising bond yields. But he said some of that move probably reflects a higher term premium.
The term premium is the extra return investors demand for holding longer-term bonds amid greater uncertainty.
Oil prices have become particularly sensitive to developments in the Middle East. That uncertainty can therefore push bond yields higher even without a major change in long-term inflation expectations.
Williams said inflation compensation is not showing the same warning signal.
For investors, that means the Treasury market cannot be interpreted simply by looking at the headline yield.
The stronger-growth interpretation does not mean the Federal Reserve can ignore inflation.
Asked whether the market could do the tightening work for the central bank, Williams said returning inflation to 2% on a sustained basis is the Fed's job, and nobody else's.
He called it job number one.
Williams said core inflation is currently around 3.3%. He attributed much of the excess above the Fed's 2% goal to tariffs and higher energy prices.
Importantly, he said there is little evidence so far of broader second-round effects.
"We're not seeing kind of second-round effects or broadening of the tariffs," Williams said.
He also pointed to anchored inflation expectations and contained wage growth as reasons for cautious optimism.
The bond market is telling a more complicated story than simply "higher yields are bad." A Fed that treats rising yields as confirmation of strength has less reason to rescue the duration trade, such as the iShares 20+ Year Treasury Bond ETF (TLT).
Higher borrowing costs will still pressure rate-sensitive sectors, particularly housing and other areas dependent on financing.
Williams acknowledged that effect.
But if yields are rising because businesses are investing aggressively and economic growth remains solid, the move does not necessarily signal an approaching recession. That creates an important distinction for equity investors.
The real risk may not be higher yields themselves. It may be a shift in what is driving them.
If growth remains strong while inflation gradually cools, rising real yields could represent an economy capable of absorbing higher financing costs.
If inflation broadens again, the same bond-market move would look very different.
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