Bond Traders Lose Faith in 2026 Fed Rate Cut on Oil, PPI

e80oc53ujppq9zv)nqsrxzya_media_dl_1.png Bloomberg

Article content

(Bloomberg) — Bond traders priced in lower odds of even a single Federal Reserve interest-rate cut this year as Middle East warfare put upward pressure on oil prices and a US inflation gauge rose more than expected. 

Article content

Markets further downgraded the chances of a rate cut as oil benchmarks approached their highest closing levels since 2022, spurred by reports an Iranian field was impaired by the latest attacks on the region by the US and Israel. Oil prices contribute to US consumer inflation in the short term via retail gasoline, where the national average is up about 30% this month.

Article content

Article content

Article content

A report on US February producer prices showed increases bigger than economists estimated, information that may influence Fed policymakers whose quarterly projections in December anticipated a quarter-point rate cut this year.

Article content

Article content

“The sticky US inflation backdrop leaves the Fed with little room to look through the oil shock, tilting the balance toward less easing,” said Elias Haddad, global head of markets strategy Brown Brothers Harriman.

Article content

The US central bank’s rate-setting committee is set to conclude a two-day meeting at which it’s widely expected to leave its target range for the US overnight lending rate at 3.5%-3.75%. However they also will update their projections for the economy and monetary policy, and their policy statement slated to be released at 2 p.m. in Washington — followed by Fed Chair Jerome Powell’s comments beginning 30 minutes later — may alter the outlook even if the projections are unchanged.

Article content

Treasury yields rose, led by short-maturity tenors that are most sensitive to changes in the Fed’s policy rate. The two-year yield climbed four basis points to 3.73%, the highest level this week.

Article content

Article content

Short-term interest rate markets that as recently as late February priced in two quarter-point rate cuts in 2026 in the past week ceased to fully price in even one. On Wednesday, the target shifted further toward mid-2027.

Article content

In interest-rate options Wednesday, flows included a large sale of a wager on a dovish Fed policy path and a large purchase of a structure that would benefit from the market pricing in higher rates than it does now.

Article content

While sustained higher energy prices are an economic burden because they sap consumer spending on other items and increase costs for businesses — a prospect that has begun to erode the link between oil and Treasury yields in the past week — their initial impact on consumer prices was evident Wednesday in the inflation-protected bond market and inflation swap rates.

Article content

Treasury inflation-protected securities, whose interest payments are determined by the consumer price index, outperformed conventional Treasuries, whose yields were stable while conventional yields rose. For the five-year tenors, the yield gap widened to about 2.72 percentage points, exceeding last year’s high. The gap represents the average CPI inflation rate needed to equalize their returns. 

Article content

The Treasury Department is slated to sell $19 billion sale of 10-year Treasury inflation-protected securities Thursday. As TIPS auctions are held only once a month, it’s the first one since the US attack on Iran on Feb. 28 disrupted oil supply from the region.

Article content

—With assistance from Miles J. Herszenhorn and Edward Bolingbroke.

Article content

(Adds interest-rate options activity and inflation-protected bond performance beginning in eighth paragraph and updates yield levels.)

Article content