By Alden Bentley
NEW YORK (Reuters) – U.S. Treasury yields fell on Tuesday after a dovish producer price report that looked unlikely to divert the Federal Reserve from a easing path, while consumer price data on Wednesday will round out the inflation picture.
The producer price index for July rose a less-than-expected 0.1% after rising 0.2% in June, the Labor Department reported, as rising costs for goods were offset by lower-cost services. In the 12 months through July, the PPI rose 2.2%, pulling back from a 2.7% increase in June.
Vail Hartman, a U.S. rates strategist at BMO Capital Markets in New York, said the CPI and PPI are not highly correlated and the market took the data in stride. The PPI shouldn’t cause the Fed to veer off course because parts of it contribute to the personal consumption expenditures price index, which the Fed primarily relies on to guide policy, he said.
“Just looking at the CPI data, and specifically the elements that feed into the core PCE, I don’t think there’s anything truly alarming, and from a broader perspective, I think the data fits the disinflation narrative.”
The report also sent stocks higher and the dollar lower.
Slowing inflation and cooling labor market have led financial markets to anticipate that the Federal Reserve will start its easing cycle in September. With inflation on track and the unemployment rate soaring to near a three-year high of 4.3% in July, a 50-basis-point interest rate cut from its current range of 5.25% to 5.50% cannot be ruled out.
The July consumer price index is due out Wednesday at 8:30 a.m. EDT (1230 GMT). Also due Thursday are indicators such as retail sales and weekly jobless claims. Claims have taken on added importance recently given the Fed’s scrutiny of labor market conditions.
“The market is expecting a confirmed slowdown in the economy that will also give the Fed more excuses to cut rates,” said Kim Rupert, managing director of fixed income at Action Economics in San Francisco.
Futures markets are pricing in about 54% odds of the Fed cutting 50 basis points, versus 46% for a 25 basis point cut, a turnaround from Monday night. Traders are pricing in a full percentage point of easing by year-end.
Atlanta Federal Reserve President Raphael Bostic said Tuesday that unemployment remains historically low and the labor market is strong, predicting a rate cut by the end of the year.
Speaking at an event in Atlanta, Bostic noted that the balance of risks between inflation and the labor market is closer to level, but he wants to be sure the Fed avoids cutting rates too soon.
Bond yields fell sharply to their lowest level in more than a year in the wake of a surprise rise in the unemployment rate and weaker-than-expected payrolls growth reported last Friday.
They have recovered somewhat but remain under pressure amid concerns that confidence in a soft landing may be excessive and a recession could be looming.
The benchmark 10-year U.S. bond yield fell 5.5 basis points to 3.854%, about 4 basis points below where it stood before the PPI.
The yield, which typically moves in line with interest rate expectations, fell 7.1 basis points to 3.9439%, most of which came after the report.
With two-year bonds failing to hold back above 4% this week, Rupert said: “The shorts are throwing in the towel again, so the little rally is feeding on itself to some extent.”
The yield on the 30-year bond fell 3.2 basis points from the previous session’s close to 4.1656%.
The gap between two- and three-year bond yields, seen as a proxy for growth expectations, stood at -9.2 basis points, slightly steeper or less inverted than Monday’s reading of -11.7 basis points. An inverted yield curve is often seen as an indicator of a recession.
Hopes for an aggressive 50 basis point easing in September briefly pushed the gap between 2- and 10-year yields to positive 1.5 basis points last week, the first time the curve showed a more normal upward slope since July 2022.
The breakeven inflation rate on five-year Treasury Inflation-Protected Securities (TIPS) rose to around 1.99% from 1.98% at Monday’s close, indicating that investors expect average annual inflation of less than 2% over the next five years.
The breakeven inflation rate on 10-year TIPS rose to 2.1158% from 2.11%.
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