The bond market is warning that something is broken and that the Fed has done enough, market veteran Ed Yardeni says

• Inverted yield curves often indicate a coming credit crunch, the market veteran said.
• But while a broad lending shortage is unlikely, the Fed should not lift interest rates any further.
• The bond market also shows that investors are betting on moderating inflation rates.

The bond market is flashing a warning that the financial system is damaged, Ed Yardeni told Bloomberg TV, with bondholders continuing to bet on future turmoil.

That should have implications for the Federal Reserve's next moves, he added, restricting further interest rate hikes.

"In the past whenever the yield curve has turned negative, that was always a precursor to something blowing up in the financial system," the market veteran said. "Leading to a credit crunch — an economy-wide credit crunch, where even good borrowers couldn't get money — and that in turn led to a recession."

The curve becomes negative when the yield on a shorter-term bond suprasses that of a longer-term one, indicating that investors expect interest rates to fall in the future — often a sign of a coming recession.

This is currently the case, with the 2-year Treasury holding a 3.82% yield, compared to a 3.31% yield on the 10-year Treasury. And earlier this year, the difference between the two notes fell to its widest in four decades.

But while the bond inversion is showing a continued pull back from long-term investing — especially in the wake of March's banking turmoil — Yardeni argues that the current situation is not enough to force a broad credit crunch.

This may due to lending facilities set up for banks after the collapse of Silicon Valley Bank, in an effort to reduce the possibility of a greater financial contagion and that has allowed institutions to continue lending.

Instead, the negative yield curve should be an indication for the Fed to halt any further interest rate hikes, he said. 

According to him, bond markets are indicating that the central bank's current rate of 5% is restrictive enough and that any further increases only risk worsening the situation and causing a hard landing. 

"I think the bond market is also expressing confidence that inflation will be moderating," he added. "I mean, nobody's gonna be buying bonds at three and a half percent if they think that inflation is going to be coming down."

Yardeni is not alone in calming concerns around a credit shortage, as the Fed President James Bullard also characterized the situation as easing. However, in his view, interest rates should continue to climb in order to combat resilient inflation rates.