• Part 1 laid out the regime itself and its prerequisite, and Part 2 covered the oil-lag transmission channels that test the prerequisite — along with the market's forward-repricing evidence.
• Part 3 sets out the four specific cases through which the regime could break, and the tentative conclusion on which scenario the market's current price is reflecting.

4. Failure Modes ⎯ How the Architecture Breaks

Failure Mode A ⎯ Inflation reignition (conditional on channel 4 historical sensitivity)

1. Oil-lag channel 4 (the channel through which sustained oil price increases manifest as 6–12 month inflation persistence concerns) fires with its historical reaction function → core PCE re-accelerates into the 3.0%+ range.
2. Market absorption pressure on Treasury bill issuance increases → upward pressure on the short end.
3. Term premium re-expands → upward pressure on 10Y / 20Y / 30Y yields.
4. The issuance-mix lever itself loses its grip.

This cascade only fires under the assumption that channel 4's historical sensitivity is still intact. The three circumstances laid out in Part 2 — the post-shale shift to a net oil producer, the non-response of expectations so far, and the FRB/US model overhaul — all push in the direction of weakening that assumption. But since we can't observe the Fed's internal model's actual reaction function from outside, we can't close off the scenario altogether.

Failure Mode B ⎯ A Warsh credibility shock

1. After Warsh's confirmation, the market reads it as a weakening of Fed independence.
2. Term premium reprices to incorporate a political risk premium.
3. Long-end yields rise despite Warsh's dovish stance.
4. Bessent's issuance-mix lever can no longer offset the long-end pressure.
5. The most ironic outcome.

Failure Mode C ⎯ A prolonged Hormuz disruption

As the Dubai futures spread analysis in Part 2 showed, the market is no longer pricing the disruption as a spot event — it's repricing it forward into the summer (June–August) delivery window. If the butterfly stays negative while the July–August spreads keep building, Hormuz hardens into a "delayed escalation" scenario rather than a transient shock, and the following cascade fires:

1. The US–Iran conflict drags on, with no clear path to a negotiated settlement.
2. Shipping and insurance premia settle in as a new baseline rather than a shock.
3. Core-goods import inflation becomes secularly elevated.
4. Inflation turns sticky in a way that goes beyond the tariff effect.
5. Channel 4 (inflation expectations) accelerates → becomes the trigger for Failure Mode A.

Failure Mode D ⎯ Normalization of reserve demand

1. Reserve demand in the banking system slows toward trend growth.
2. The "maintain ample reserves" justification for RMP weakens.
3. The Fed scales back RMP regardless of the inflation backdrop.
4. The bill-absorption autopilot weakens — the issuance-mix lever partially seizes.

5. Tentative Conclusion

The Bessent–Warsh regime's prerequisite is that channel 4 (inflation expectations) doesn't fire with its historical sensitivity. Whether that condition holds isn't directly observable from outside — it can only be read after the fact through subsequent data releases.

At this point, both scenarios remain plausible.

• The historical-cascade base case (Failure Mode A) involves (1) direct CPI and core-PCE impact from energy price increases over the next 2–3 quarters, and (2) UMich inflation expectations drifting higher to confirm channel 4 activation.
• The weakened-sensitivity scenario is the one where channels 1–3 are already in mid-transmission on the cost-passthrough side, channel 4 lands with less reach than its historical baseline, and the regime keeps operating while still meeting its inflation prerequisite.

Current market pricing (10Y 4.37%, 30Y 4.95%, as of May 8) sits roughly at the midpoint between these two scenarios.

• Under stress, the 10-year yield re-enters the 4.6–4.8% box, and at that point the political cost of the Bessent–Warsh framework becomes fully visible.
• Conversely, if the oil price increases pass through without meaningfully affecting forward inflation concerns, the framework itself runs self-reinforcing through H2 2026.

Release watchlist

The release sequence to track for decisive evidence:

• The energy-cost contribution within Feb–May 2026 CPI prints.
• The pass-through into core goods and services components of core PCE.
• The energy-cost contribution to PPI (the March 18 release is the first PPI print after the oil shock).
• Continuous monitoring of UMich and NY Fed inflation-expectations releases.

To summarize, the path forward bifurcates:

• Scenario A ⎯ the regime holds: the indicators cumulatively confirm that channel 4's historical sensitivity has weakened (i.e., channel 4 cannot be established), and the regime keeps operating while meeting its inflation prerequisite.
• Scenario B ⎯ the regime hits stress: those same indicators instead make the historical cascade visible in mid-stream (particularly if the long-term inflation-expectations tail in the UMich and NY Fed surveys starts to re-steepen), and the political cost of the Bessent–Warsh regime becomes fully visible.