Bond yields rise slightly as traders await crucial inflation data

Bond yields rose on Tuesday as traders showed reluctance to buy fixed-income assets ahead of inflation data that could impact the Federal Reserve’s thinking on the path of interest rates .

What is happening
  • The 2-year Treasury yield TMUBMUSD02Y,
    added less than 1 basis point to 3.214%. Yields move in the opposite direction to prices.

  • The 10-year Treasury yield TMUBMUSD10Y,
    climbed 3.7 basis points to 2.795%.

  • The 30-year Treasury yield TMUBMUSD30Y,
    rose 2.3 basis points to 3.013%.

  • As of Monday’s close, the 10-year yield was down 72 basis points from its cycle high reached in mid-June, but was still up 127 basis points for the year to date.

What drives the markets?

Over the summer, the focus of trade is on the US Consumer Price Index report for July, due out on Wednesday.

Benchmark 10-year Treasury yields have fallen sharply from a multi-year high reached in mid-June, partly on hopes that inflation has peaked and the Federal Reserve may not have not be as aggressive in raising interest rates as feared. High inflation makes fixed income assets less attractive.

Economists predict that lower energy prices will help headline CPI inflation year-over-year to rise from a 40-year high of 9.1% in June to 8.7% last month.

But some analysts worry that even if that happens, the market could quickly recognize that underlying inflation remains very stubborn.

“While we all expect the overall year-over-year pace to slow, core inflation is likely to pick up. Heart. You know, the measure of inflation that is a “ better representation of the underlying economy” according to [Fed chairman] Powell,” said Tom Porcelli, chief U.S. economist at RBC Capital Markets, in a note to clients.

He continued, “In the context of seemingly all Fed officials diligently beating the table they need to beat inflation, how does the Fed justify resigning in September with core acceleration (and probably a further acceleration in the report after this one thanks to unfavorable compositions a year ago)? It seems to us that such a reaction function would contradict the rhetoric”.

Wells Fargo is equally cautious. The bank says it is more important than reaching the peak of headline inflation to “determine whether the components of underlying inflation will remain rigid and how long it will take the Fed to bring inflation back at 2%”.

Yet there has been better news on inflationary pressures. The New York Federal Reserve’s monthly survey of consumer expectations for July, released earlier this week, showed that respondents expect inflation to be around 6.2% over the next next year and fall to a rate of 3.2% over the next three years.

“It will be music to the ears of the Fed, because if this trend continues, it means the Fed may not have to be as aggressive in raising rates, because one of their big fears is that higher inflation expectations will lead to a self-fulfilling prophecy of higher real inflation as companies adjust prices and workers negotiate wages accordingly,” Deutsche Bank strategists said.

Markets are pricing in a 66.5% 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 3.623% by April 2023, according to Fed Funds futures.

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