Bond Traders Suspect Fed Is Flirting With Policy Error

In other words, the Fed's moves have given it little room to drop rates in the future while dimming the outlook for economic expansion in years to come. That looks a lot like a policy error.

The Fed is in a difficult spot right now. Not only is it trying to normalize policies at a time of unimpressive economic growth, but it is doing so as its fellow central bankers in Europe and Asia maintain ultra-easy monetary policies, thus pushing investors into less-creditworthy stocks and bonds. It's unclear how much power the Fed has to unilaterally squelch this rush to yield, which has pushed valuations to concerning levels.

What these central bankers need to validate their moves is inflation, and that's proving remarkably elusive. Perhaps that's because oil prices have been relatively low in recent years, but there are also indications that consumers aren't spending quite as much, another concerning signal for the months ahead.

Bond traders are clearly worried that U.S. central bankers are on a path to harm the nation's prospects for growth without meaningfully adding to its arsenal of tools to deal with any downturn. The debt markets have an uncanny ability to be more right than wrong. It's worth paying attention to their message.

— Read Who's Driving Fed Policy? Most Voting Seats Are Empty on ThinkAdvisor.