Treasuries Gain as Inflation Gauge Cools Fed Rate-Hike Bets

s6}100ibshi)waos)81fs2xt_media_dl_1.png Bloomberg

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(Bloomberg) — Treasuries gained after the Federal Reserve’s favored inflation gauge rose less than estimated, damping expectations for an interest-rate hike in the months ahead. 

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The advance on Thursday pushed yields on two-year notes, most sensitive to the prospect of changes in Fed policy, lower by more than four basis points to 4.10%. Those on benchmark 10-year notes fell two basis points to 4.37%. The 30-year touched 4.82%, the lowest level since March.

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Interest-rate swaps linked to future Fed rate decisions showed a drop in wagers on a hike this year, pricing in about 33 basis points of tightening by the December policy meeting versus some 36 basis points at Wednesday’s close. The chance of a rate increase next month dwindled to about one-in-three.

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The Fed’s favored inflation gauge — the price index for personal consumption expenditures, or PCE — rose 0.4% in May, compared with the median estimate of 0.5% in a Bloomberg survey of economists. The annual rate, which the central bank aims to keep around 2% in the long run, increased to 4.1%. 

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Core PCE prices, which exclude food and energy, rose 0.3%, in line with expectations. The year-on-year increase was 3.4%, the highest since 2023. Bond investors are closely monitoring whether the temporary oil-price surge unleashed by the US war on Iran in late February is leading to more broad-based price increases.

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The inflation gauge “was a bit softer than feared, which is helping the rally continue and the front end perform a bit better,” said John Briggs, head of US rates strategy at Natixis.

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Two-year Treasury yields reached a 16-month high 4.23% Monday in the wake of last week’s Fed policy meeting, the first of Chairman Kevin Warsh’s tenure. Updated quarterly forecasts by members of the Federal Open Market Committee showed broadening support for a rate increase this year, and comments by Warsh calmed investor fears he’d yield to White House pressure to cut rates despite elevated inflation.

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Since then, oil prices declined further, approaching pre-war levels. Treasuries responded by pricing in lower expected inflation rates, with additional support from a setback for US technology shares that stoked demand for haven assets.

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In the options market linked to the Secured Overnight Financing Rate, a market interest rate guided by Fed policy, there’s been demand this week for positions that benefit from a decline in expectations for rate hikes in the coming months, open-interest data show.

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There’s also been a wave of demand for bullish positions in Treasury options, including August calls on 10-year note futures that would benefit from a drop in yields below 4.4%. August options expire July 24 in the week before the July 29 Fed decision.