Bond Traders Ditch July Rate-Hike Bets on Surprise Inflation Dip

1)gqbph7hyk4mygov55]hz6)_media_dl_1.png Bloomberg

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(Bloomberg) — An unexpectedly sharp slowdown in inflation unleashed a rally in the US bond market as traders rapidly unwound bets that the Federal Reserve could begin raising interest rates as soon as this month. 

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The move marked another swift about-face on Wall Street, where speculation that the central bank might push rates higher at its July 29 meeting had been steadily building due to hawkish comments from central bankers and the renewed fighting between the US and Iran that’s sending oil up again. But the report from the Labor Department that consumer prices in June posted the first month-to-month drop since 2020 was seen as almost certain to buy the Fed some time. 

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Futures traders pushed the likely timing of the Fed’s rate hike back to September or October. Stocks rose. The dollar dropped against every other major currency. And two-year Treasury yields, which closely track monetary policy changes, tumbled as much as 14 basis points to 4.14%, the biggest drop since August, before paring the decline.

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“Today’s print takes a July hike off the table,” said Zach Griffiths, head of investment grade and macro strategy at CreditSights. “While inflation is still too high and the situation in the Middle East is deteriorating, today’s data should give them enough cover to stay in wait-and-see mode.”

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The Treasury rally faded some as the trading day wore on, with two-year yields down around 8 basis points by early afternoon, after Fed Chairman Kevin Warsh struck a hawkish tone during testimony on Capitol Hill. Warsh, who took over for Jerome Powell in May, said policymakers are committed to reining in inflation that’s been over the Fed’s 2% target since the pandemic. He also downplayed the significance of the June figures, saying they didn’t indicate that “everything is well.”

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Even so, traders saw the easing price pressures as sufficient to keep the Fed on hold this month, at least temporarily extending the pause the central bank has had in place since it stopped cutting rates at the end of last year. One closely watched measure of inflation, which excludes volatile food and energy prices, was unexpectedly unchanged from a month earlier.

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“This will relieve some pressure on the Fed to hike rates this year,” said Tracy Chen, portfolio manager at Brandywine Global Investment Management. “But with the new norm on the Iran war front, we might not be out of the woods yet.”

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Longer-term market rates jumped after President Donald Trump started the Iran war in late February as the oil shock rippled through the global economy, increasing anticipation that the Fed and other central banks would need to tighten monetary policy to keep consumer prices from spiraling.

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Speculation that the Fed would start doing that as soon as this month has flared off and on ever since Warsh’s first post-meeting press conference last month, when he underscored the Fed’s commitment to getting inflation back to its target.