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As equity and bond investors focus on this week’s upcoming U.S. Federal Reserve meeting, I worry that they may be asking the wrong question.

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Bond traders are now pricing in two to three quarter-point rate hikes over the next 12 months, with a meaningful probability that the first could arrive as soon as this week. The two-year Treasury yield, which closely tracks expectations for future Federal Reserve policy, has risen well above the current fed funds rate. The message from the bond market is clear: Investors appear convinced that Federal Reserve chair Kevin Warsh is prepared to lean harder against inflation following his recent hawkish remarks at the annual Jackson Hole meeting.

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The problem many investors are missing is that the inflation we’re seeing today isn’t being driven by excessive consumer demand, an overheated housing market or a wage-price spiral. In fact, the wage data suggest the exact opposite.

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Growth in average hourly earnings has slowed steadily from nearly six per cent in the U.S. in early 2022 to approximately 3.1 per cent as of August 2026. At the same time, real wages have turned negative again, meaning inflation is once again rising faster than paycheques. This comes after years of excessive fiscal and monetary stimulus that have significantly eroded the purchasing power of the dollar. Households are now being squeezed further by rising energy, transportation, food and housing costs.

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So please explain how higher borrowing costs are going to improve their situation. How exactly do higher interest rates produce more barrels of oil, more natural gas or more refined petroleum products?

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U.S. Treasury Secretary Scott Bessent recently highlighted this issue, arguing that the current inflation backdrop increasingly resembles a supply shock rather than a traditional demand-driven inflation cycle. Yet markets continue to price additional tightening.

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The problem as history suggests is that when policymakers attempt to fight supply-driven inflation with demand-destroying tools, the economy can drift toward a much uglier outcome: stagflation.

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For those who lived through the 1970s, it was an economic nightmare. Economic growth slowed, unemployment rose and consumer confidence deteriorated, yet inflation remained stubbornly high because energy shortages continued pushing costs upward.

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The origins of that crisis were relatively straightforward, and in many ways resemble the pressures we’re facing today. The 1973 OPEC oil embargo and the Iranian Revolution later in the decade sharply reduced global energy supplies. Oil prices surged, transportation costs increased, manufacturing costs climbed and food prices followed.

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Central banks responded with repeated rounds of monetary tightening that compounded the economic damage already being inflicted by the supply shock. At least at the time there was a rationale. Wage growth accelerated, labour unions had greater bargaining power and policymakers were increasingly concerned about a wage-price spiral becoming embedded in the economy.