Baird Fixed Income Insights: Convexity Pulse
Jul 20, 2026 · 25 min · 9 segments
In this week's Convexity Pulse, Kirill Krylov and Steven Scheerer discuss why mortgage investors may be placing too much emphasis on day-to-day Fed expectations and too little on the structural forces…
Kirill KrylovHost
Steven ScheererHost
Steven, this week was a good reminder to us that markets can change their minds in a hurry.
One softened unexpected CPI report was really enough to push the implied probability of a September rate hike below 50%, believe it or not.
And suddenly investors started talking about the Fed sitting on the sidelines again.
And by the end of the week, the odds of another hike had climbed back above that dangerous 50% threshold.
What's interesting to me, Stephen, isn't necessarily the day-to-day movement in rate expectations.
Where I think this discussion becomes even more curious is whether another 25 basis points or so rate hike is really the best tool to address the inflation that's increasingly influenced by supply-side pressures and, of course, geopolitics, baby.
If higher oil prices are driven by developments in the Middle East, tighter monetary policy may not be the most efficient answer.
Yeah, you know, we sometimes talk as if the Fed has only one instrument, when in reality it has two.
Everyone focuses on short-term rates, but balance sheet policy is also part of the toolkit.
Given Governor Logan's background overseeing the balance sheet operations at the New York Fed, it's somewhat surprising that quantitative tightening isn't receiving more attention in the inflation discussion.
Shipping activity has declined materially since tensions escalated, and while there are occasional signs that diplomacy could gain traction, the risk of further escalation hasn't disappeared.
If energy infrastructure or additional shipping routes become involved, inflation could once again be driven by supply disruptions rather than domestic demand.
Steven, this week was a good reminder to us that markets can change their minds in a hurry.
One softened unexpected CPI report was really enough to push the implied probability of a September rate hike below 50%, believe it or not.
And suddenly investors started talking about the Fed sitting on the sidelines again.
And by the end of the week, the odds of another hike had climbed back above that dangerous 50% threshold.
What's interesting to me, Stephen, isn't necessarily the day-to-day movement in rate expectations.
Where I think this discussion becomes even more curious is whether another 25 basis points or so rate hike is really the best tool to address the inflation that's increasingly influenced by supply-side pressures and, of course, geopolitics, baby.
If higher oil prices are driven by developments in the Middle East, tighter monetary policy may not be the most efficient answer.
Yeah, you know, we sometimes talk as if the Fed has only one instrument, when in reality it has two.
Everyone focuses on short-term rates, but balance sheet policy is also part of the toolkit.
Given Governor Logan's background overseeing the balance sheet operations at the New York Fed, it's somewhat surprising that quantitative tightening isn't receiving more attention in the inflation discussion.
Shipping activity has declined materially since tensions escalated, and while there are occasional signs that diplomacy could gain traction, the risk of further escalation hasn't disappeared.
If energy infrastructure or additional shipping routes become involved, inflation could once again be driven by supply disruptions rather than domestic demand.
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