Treasury yields fall as traders watch inflation data
Bond yields fell on Wednesday, but moves were thin and trading was thin as the market waited for the latest indicator of US inflation.
What is happening
The 2-year Treasury yield TMUBMUSD02Y,
fell 4 basis points to 3.226%. Yields move in the opposite direction to prices.
The 10-year Treasury yield TMUBMUSD10Y,
fell 3 basis points to 2.772%.
The 30-year Treasury yield TMUBMUSD30Y,
fell 1 basis point to 2.985%.
The 10-year to 2-year gap of minus 46 basis points means the yield remains close to its most inverted level in 20 years, potentially a strong signal of an economic slowdown.
What drives the markets?
The U.S. Consumer Price Index (CPI) report due at 8:30 a.m. EST is the primary focus for bond investors.
Bond bulls are hoping the previous report covering June, which showed year-on-year CPI at a 40-year high of 9.1%, will mark the peak of headline inflation. Consensus forecasts show the stock falling to 8.7% on lower energy prices.
Hopes that the pace of inflation could soon start to wane helped yields on benchmark 10-year Treasuries fall from around 3.5% in June to 2.778%. But analysts warn that the market will need to see evidence that core inflation, which excludes volatile commodities like food and energy, is also starting to stabilize for the bond rally to hold.
Economists forecast the core CPI year-over-year to rise from 5.9% in June to 6.1% in July.
Jan Nevruzi, U.S. rate strategists at NatWest Markets, said if the core figure matches economists’ forecasts, investors could expect a slightly less hawkish Fed.
“As far as market reaction is concerned, I think an impression consistent with those [forecasts] would bring the Fed’s September expectations closer to 50 [basis points]while all of the above would raise the profile for terminal 2022 by around 15-20 basis points, but setting more cuts from Q2 23.”
But Nevruzi warned that such a view could be premature.
“There is more inflation data ahead of the September meeting and a lot can change, but that seems like potential knee-jerk reactions to me. thing for the Fed, as it needs to see at least a consistent multi-month trend to turn around, while accelerating inflation means there is still a long way to go on the tightening front,” Nevruzi wrote in a note to customers.
Alan Ruskin, Macro Strategist at Deutsche Bank, said in a note: “In terms of reactions, the market will initially be more excited by a downside surprise in core CPI than an upside surprise, particularly in risk appetite A downside surprise plays on “hopes” that a spike in oil/food, along with a slowdown in demand, will quickly feed through to US inflation data. This is probably wishful thinking, as inflation typically lags demand by at least a year.
Ruskin added that a softer CPI reading would still support the “maximum inflation theme.” “It will also play to the market’s recent propensity to buy risk dips, and be a broad-based negative effect for the USD, especially against high-beta emerging markets.”
Markets are currently pricing in a 67.5% chance that the Fed will raise interest rates another 75 basis points to a range of 3.00% to 3.25% after its September 21 meeting. The central bank is expected to raise borrowing costs to 3.66% by April 2023, according to Fed Funds futures.