Treasuries Rally as Cool CPI Data Cuts July Fed Hike Bets to 20%

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(Bloomberg) — US Treasuries rallied and traders pulled back from bets on near-term Federal Reserve interest-rate hikes after consumer prices data came in lower than forecast.

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The yield on two-year Treasuries — which are sensitive to the near-term outlook for Fed monetary policy — fell as much as 14 basis points to 4.14%, on course for its biggest one-day decline since February. The probability that the US central bank raises rates later this month, as implied by the interest-rate swap market, fell to about 20% from 40%.

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The figures offered relief to bondholders and US policymakers who’d been weighing the need for swift action to bring inflation back toward the Fed’s 2% target. Earlier this week, traders had increased bets on a July Fed hike as renewed warfare between the US and Iran sent oil prices higher.

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“It’s a broad-based downside surprise,” said Dan Carter, senior portfolio manager at Fort Washington Investment Advisors. “Near-term hikes are off the table. The market has been fearful of a hot print, so this should be supportive for bonds and re-steepen the curve. Our base case is the Fed will remain on hold. This print supports that notion.”

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The US Treasury market’s rally on Tuesday was set to pare a loss of more than 2% since the US and Israel attacked Iran in late February, according to data compiled by Bloomberg. The dollar, meanwhile, fell to its weakest level in a month — reinforcing the divergence between the US currency and bonds.

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In June, easing hostilities helped relieve pressure in the energy market. The consumer price index fell 0.4% from May, dragged down by the biggest decline in gasoline prices since 2022, according to Bureau of Labor Statistics data. Excluding food and energy, the index was flat from the prior month.

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But the truce between the US and Iran has since deteriorated, and fresh attacks on shipping in the Strait of Hormuz this week pushed Brent oil above $87 a barrel for the first time in a month. 

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It creates a complicated picture for investors as they look to commentary from Fed Chairman Kevin Warsh this week. While the new Fed boss is slated to testify in front of the House Financial Services Committee in Washington, he’s shown an aversion to making predictions about the Fed’s course in past public appearances. 

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He’s set to tell lawmakers that policymakers have no tolerance for high inflation. Market pricing shows traders are betting on a quarter-point rate hike by October.

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For Warsh, “today’s print should allow some breathing room,” said Christopher Hodge, chief US economist at Natixis. “After coming out swinging as a hawk, a hotter-than-expected CPI print could have backed him into a corner and forced a hike.”

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—With assistance from Edward Bolingbroke and Cameron Fozi.

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(Updates prices, adds context throughout, adds Natixis quote in final paragraph.)

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