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Bond Report: U.S. bond yields inch higher as traders await Wednesday’s crucial inflation data


U.S. bond yields nudged higher on Tuesday, as traders displayed reticence to buy fixed-income assets ahead of inflation data that may impact Federal Reserve thinking on the path for interest rates.

What’s happening

The yield on the 2-year Treasury

added less than 1 basis point to 3.214%.

The yield on the 10-year Treasury

climbed 3.7 basis points to 2.795%.

The yield on the 30-year Treasury

rose 2.3 basis points to 3.013%.

By Monday’s close the 10-year yield was down 72 basis points from its cycle high touched in mid-June, but remained up 127 basis points for the year-to-date.

What’s driving markets

In thin summer trading attention is fixed on the U.S. consumer price index report for July, due for release on Wednesday.

Benchmark 10-year Treasury yields have fallen sharply from the multi-year high touched in mid-June, partly on hopes that inflation has peaked and the Federal Reserve may not have to be as aggressive in raising interest rates as had been feared.

Economists forecast that a dip in energy prices will help headline year-on-year CPI inflation fall from the 40-year high of 9.1% in June to 8.7% last month.

But some analysts are wary that even if this occurs, the market may quickly recognize that underlying inflation remains very stubborn.

“While we all expect the headline year-on-year pace to slow, core inflation will likely accelerate. Core. 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 added: “In the context of seemingly every Fed official diligently pounding the table that they need to beat up on inflation, how does the Fed justify stepping down in September with an acceleration in core (and likely a further acceleration in the report after this one thanks to unfavorable year-ago comps)? It strikes us that such a reaction function would be at odds with the rhetoric”.

Wells Fargo is similarly cautious. The bank says that more important than reaching peak headline inflation is “determining if core inflation components are going to remain sticky, and how long it will take the Fed to get inflation back to 2%.”

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

“That’ll be music to the Fed’s ears, since if that trend continues then it means that the Fed may not have to be so aggressive in hiking rates, since one of their big fears is that higher inflation expectations will lead to a self-fulfilling prophecy of higher actual inflation as firms adjust prices and workers bargain for wages accordingly,” said strategists at Deutsche Bank.

Markets are pricing in a 66.5% probability that the Fed will raise its benchmark interest rate by another 75 basis points to a range of 3.00% to 3.25% after its meeting on September 21st. The central bank is expected to take its borrowing costs to 3.623% by April 2023, according to Fed Funds futures.

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