Most Treasury yields fell sharply on Wednesday, led by the rates on 2- and 3-year notes, after a better-than-expected U.S. inflation report encouraged investors to pare bets on aggressive interest rate hikes by the Federal Reserve.
The yield on the 2-year Treasury
declined 7 basis points to 3.214% from 3.284% on Tuesday afternoon. That’s the largest one-day decline since Aug. 4, based on 3 p.m. yields, according to Dow Jones Market Data.
The yield on the 10-year Treasury
retreated 1.1 basis points to 2.786% from 2.797% late Tuesday. The yield is off 69.6 basis points from its cycle high reached on June 14.
The yield on the 30-year Treasury
rose 3.7 basis points to 3.041% from 3.004% on Tuesday.
The 2-year to 10-year spread narrowed to minus 40 basis points from almost minus 50 basis points, but the yield curve remains close to its most inverted in two decades in a potential signal of an economic downturn.
Meanwhile, Treasury’s $35 billion 10-year note auction produced “very strong buyside takedown,” according to economists Thomas Simons and Aneta Markowska at Jefferies.
What’s driving markets
The U.S. consumer price index (CPI) report released on Wednesday showed year-on-year inflation in July of 8.5%, down from 9.1% in June and below the 8.7% forecast by economists. The pullback in inflation was largely caused by falling energy prices, but there was better news on core prices, too.
The year-on-year core price measure — which strips out volatile food and energy costs and is considered a better indicator of how “sticky” inflation could be — came in at 5.9%, the same as June and below the 6.1% feared by analysts. It was the first time since April that the CPI report “brought unexpected good news on inflation,” said FHN Financial’s chief economist Chris Low.
Investors piled into bonds and stocks on Wednesday, leaving the Dow industrials up more than 500 points in the final hour of trading. Meanwhile, Chicago Fed President Charles Evans said the U.S. July consumer inflation data was “positive,” but “nobody can be happy” about an 8.5% annual headline CPI rate. And Minneapolis Fed President Neel Kashkari said that the Fed is “far, far away from declaring victory.”
“The deceleration in the Consumer Price Index for July is likely a big relief for the Federal Reserve, especially since the Fed insisted that inflation was transitory, which was incorrect,” said Nancy Davis, founder of Quadratic Capital Management.
“If we continue to see declining inflation prints, the Federal Reserve may start to slow the pace of monetary tightening,” Davis added.
Paul Ashworth, chief U.S. economist at Capital Economics was more cautious: “Overall, with headline inflation still at 8.5% and core inflation at 5.9%, this is not yet the meaningful decline in inflation the Fed is looking for. But it’s a start and we expect to see broader signs of easing price pressures over the next few months.”
Still, markets moved swiftly to reprice the prospects for Fed monetary tightening. Before the report was released traders were giving a 67.5% chance of a 75 basis point rate hike at the Fed’s September meeting. That was down to 37.5% and the chances of a 50 basis point hike were 62.5%, according to the CME FedWatch Tool.
The central bank is mostly expected to take its borrowing costs to a range of between 3.5% and 3.75% by next March, according to fed funds futures traders.