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Read: Stocks appear ‘rate sensitive once again’ as bond yields press higher

The week ahead brings the next big U.S. inflation update, in the form of the December consumer-price index on Wednesday.

During the past week, market-based expectations of future inflation known as 5-, 10-, and 30-year breakeven rates inched further above the Fed’s 2% target to their highest levels since last April or May. Separately, minutes of the central bank’s most recent meeting in December showed that almost all policymakers saw increased upside risks to inflation, even as they delivered their third and final rate cut of 2024 — ending the year with a fed-funds rate target between 4.25% and 4.5%, down from a previous 16-year high of 5.25% to 5.5%.

For portfolio manager Brian Mulberry, of Chicago-based Zacks Investment Management, and former hedge-fund portfolio manager Guy Haselmann, the bond market’s unusual moves indicate there’s a risk that inflation may rear its head again. In addition, any decision by incoming President Donald Trump to implement tariffs and mass-deportation policies threatens to put even more upward pressure on actual inflation and expectations for future price increases in the near term, they said.

Right now, “inflation is clearly recovering, bouncing, trending up — however you want to phrase it,” Mulberry said via phone. He cited the three-month annualized core rates on both CPI and the Fed’s preferred inflation gauge, the personal-consumption expenditures price index, for October through December. They each came in close to or above 3%, said Mulberry, whose firm oversees roughly $20.4 billion in assets.

“What you are seeing in the bond market is a reflection that it’s too soon to call inflation over. There’s still a lot more work to do, and we are probably at the end of the Fed’s easing cycle for now,” he said. This means “we get roughly 4% interest rates for the foreseeable future. It would be a worst-case scenario if the Fed has to raise rates because the equity market hasn’t priced that in at all, and it would be an admission of a mistake.”

In the past few months, investors have been aggressively selling off the 10-year government note, as well as the 20- and 30-year Treasury bonds — sending yields on all three on a march toward 5%. The last time the 10-year yield briefly breached 5% was in October 2023, and a repeat of this in the days or weeks ahead is seen as a possible buying opportunity for investors who don’t currently own the underlying government note.

Read: Why a 5% 10-year Treasury yield could be a buying opportunity

An environment of elevated interest rates means investors need to be prepared for a period of volatility in stocks. A higher cost of capital than previously thought tends to undermine valuations in the growth sector and on consumer-discretionary names, as well as small- and midsized companies. Banks could also be impacted by the inability to be involved in as many initial public offerings or mergers and acquisitions as they expected. Meanwhile, utilities tend to be more insulated from stock-market selloffs due to relatively stable demand for essential services.

Read: Tech stocks got slammed because economic data sparked a jump in bond yields

The last time the 10-year yield simultaneously jumped by about as much as the Fed was cutting interest rates was in 1981.

In late 1980 and early 1981, the Fed, led by then-Chair Paul Volcker, tightened the money supply in a way that enabled the central bank’s main interest-rate target to climb to an all-time high approaching 20%. Officials had been moving rates both up and down over the course of 1980, instead of gradually in one direction, to combat rampant inflation and offset the recession that resulted from their own policies.

From mid-January to mid-October of 1981, policymakers lowered interest rates by 4.5 percentage points to between 14.5% and 15.5%, from 19% to 20% — albeit in an up-and-down manner, according to records of the moves from the Fed’s board in Washington.

Something very unusual happened during those months: The Treasury yield jumped to an all-time high of just above 15.8% in September 1981, from around 12% at the start of that year — a climb of almost 4 percentage points. The following year, 1982, brought another round of up-and-down moves in the direction of interest rates.

According to Haselmann, a former strategist for Toronto-based Scotiabank who now works as a consultant, the direction of Treasury yields can often be influenced by an array of factors. But when the 10-year rate rises by as much as it has after the Fed has been in rate-cutting mode, “it’s all about inflation expectations.” The “only explanation for what’s occurring now is that the marketplace has inflation expectations that are rising,” which puts the Fed “in a quagmire.”

“Some people may cite a large fiscal deficit and Treasury supply for rising rates, but those were known variables when the 10-year was at 3.6% before the first rate cut — so that has some influence, but is not the catalyst for the 100-basis-point-plus increase,” he told MarketWatch.

“Inflation is not controlled yet and the expectation remains that the Fed is not going to be able to achieve its 2% mandate in the near future,” Haselmann said via phone. When the Fed is aggressively lowering rates —as it did with a 50-basis-point cut in September and total of another 50 basis points in November and December — and inflation expectations are rising, “that is directly manifesting itself in the long end of the Treasury curve.”

He added: “I think what is going to happen this year is that the Fed is going to be extremely patient in either direction. In other words, it would not surprise me if the Fed does not cut at all in 2025. And I should add that I don’t necessarily think the Fed is likely to hike, either, even if inflation rises from here, because both higher inflation and rates will act as economic headwinds. The market has built-in, self-correcting mechanisms. The equity market, which has been fully priced for a good economic scenario, will also begin to correct down to more reasonable valuations.”

He sees a likelihood that the 10-year rate tests 5% and the 30-year yield exceeds 6% in the first half of this year, which could attract a “ton of buyers.” Investors will need their portfolios to be “a little safer and less aggressive to weather a lot of different storms, including increased volatility.”

A litany of other explanations have been floated about what’s happening in the bond market now. Nicholas Colas, co-founder of DataTrek Research, said he thinks the “historical anomaly” of a 10-year yield that’s risen by as much as the Fed has lowered rates over the same period boils down to still decent growth. Meanwhile, Nobel-winning economist Paul Krugman raised the possibility that the market is factoring in an “insanity” premium to account for the “crazy things” that Trump has said about economic policy.

Read: Paul Krugman thinks bond yields may be rising due to an ‘insanity premium’

The December CPI report, out Wednesday, is perhaps the biggest data highlight of the week ahead.

On Tuesday, the producer-price index for last month is set for release, along with the Federal Reserve’s Beige Book report and the NFIB Small Business Optimism Index. Wednesday brings the Empire State and Philadelphia Fed manufacturing surveys for January, as well as the home-builder confidence index and data on business inventories.

Weekly initial jobless claims are being released on Thursday, along with December data on retail sales and import prices. On Friday, traders will see December data on housing starts, building permits, industrial production, and capacity utilization.