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Friday, August 12, 2022

Treasury yields nudge lower and tension rises ahead of crucial CPI report

U.S. benchmark bond yields fell on Wednesday, though trading was cautious ahead of crucial inflation data that may impact Federal Reserve thinking on the path for interest rates.

What’s happening
  • The yield on the 2-year Treasury
    TMUBMUSD02Y,
    3.045%

    was barely changed at 3.049%. Yields move in the opposite direction to prices.

  • The yield on the 10-year Treasury
    TMUBMUSD10Y,
    2.955%

    retreated 1.2 basis points to 2.964%.

  • The yield on the 30-year Treasury
    TMUBMUSD30Y,
    3.146%

    was less than a basis point softer at 3.163%.

What’s driving markets

Moves were meager and tension was high as traders waited for the U.S. consumer prices data due at 8.30am Eastern. Economists expect year-over-year inflation to hit 8.8% in June, up from 8.6% the month before.

A higher-than-forecast read will raise fears that the Federal Reserve may have to become even more aggressive in hiking interest rates, risking pushing the U.S. economy into recession and forcing longer-duration Treasury yields sharply lower.

The 10-year to 2-year spread of minus 8.5 basis points means the yield curve remains at its most inverted since 2007, already potentially signaling a looming economic downturn.

10-year Treasury yield minus 2-year Treasury yield


Tradingview chart, FRED data.

Markets are pricing in a 90.6% probability that the Fed will raise interest rates by another 75 basis points to a range of 2.25% to 2.5% after its meeting on 27th July. The central bank is expected to take its borrowing costs to 3.4% by April 2023, according to Fed Funds futures.

“Recession angst remains the key focus across markets low on liquidity due to the current holiday season,” said strategists at Saxo Bank.

Saxo added that a fake CPI number circulated on Wall Street on Tuesday “shows the markets nervousness ahead of today’s U.S. inflation report, which is expected to show an acceleration to a fresh four-decade high just below 9%, thereby supporting another big rate increase from the FOMC on July 27”.

However, there were signs that investors are starting to trim their forecasts for the pace of future inflation. The 5-year break-even rate, a fixed-income derived measure of inflation expectations, has fallen over the past month from 3.18% to 2.54%, according to Tradeweb.

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