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Post: Bond Report: U.S. bond yields nudge lower as cooler inflation report reverberates

Treasury yields were a touch softer on Thursday, as traders continued to absorb signs of cooling U.S. inflation and its implications for the trajectory of monetary policy.

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A calmer tone pervaded U.S. fixed-income markets after the volatility of the previous session. Benchmark bond yields had whipsawed on Wednesday as traders tried to assess whether a softer-than-expected CPI report marked a peak for inflation and to what extent the data might cool the Federal Reserve’s hawkish tone.

The CPI index was flat for July, taking the year-on-year rise to 8.5%, down from 9.1% in June and lower than the 8.7% predicted by economists.

The producer prices report due at 8.30. am. Eastern will provide further information about inflationary pressures up the pipeline.

But until then analysts were continuing to parse the consumer prices data, with many expressing concern that the market may be too optimistic in betting the Fed will ease the pace of interest rate rises.

“It is probably too soon to “lock in” a slower pace of rate hikes from here…Fed speakers seemed to point in this same direction, with both Kashkari and Evans each echoing a similar refrain – the softer inflation print is welcome, but not enough to declare victory, ” said Brian Daingerfield, head of G10 FX strategy at NatWest Markets.

Ellen Zentner, chief U.S. economist at Morgan Stanley, said the Fed would welcome the dip in headline inflation because it may help in preventing consumer inflation expectations from staying stubbornly high.

“But trends in core are more indicative of the trajectory for underlying inflation pressures, and even though the core aggregate slowed down a lot from the previous month, Fed officials are unlikely to see this report as a signal to deviate from their steep tightening path we foresee through the end of this year,” Zentner added.

Tom Porcelli, chief U.S. economist at RBC Capital Markets, was a bit more hopeful that the report meant the Fed may be restrict its September interest rate rise to 50 basis points “and then finish the cycle with a 25 in December”.

“What does all of this mean for the Fed? They will tell you they still have a lot of work to do, and the job is not even close to done etc etc. We get it. They have to say that right now. They cannot risk a notable easing in financial conditions. But there is no doubt this report came as a massive source of relief,” Porcelli said.

Markets are pricing in a 62.5% probability that the Fed will raise interest rates by another 50 basis points to a range of 2.75% to 3.00% after its meeting on September 21st. Before the inflation report the market gave a 68% chance of a 75 basis point hike. The central bank is expected to take its borrowing costs to 3.58% by April 2023, according to Fed Funds futures.

The Treasury will hold an auction at 1p.m. Eastern, offering $21 billion of 30-year bonds.

A $35 billion auction of 10-year Treasuries that took place in the wake of Wednesday’s inflation report showed strong demand, according to Thomas Simons, money market economist at Jefferies.

“The strength of the bid today [Wednesday] may have been fueled by short-covering, as 10s ripped higher after the CPI data this morning. The market seems to have found some stability around the auction stop, and we expect that this is where the market is going to be anchored at least until we get to Jackson Hole [Fed symposium],” said Simons.

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