US Treasuries are headed for their biggest monthly rally of the year after the Federal Reserve’s favored inflation gauge decelerated, bolstering expectations for interest-rate cuts starting this year.
The rise in bonds pushed 10-year yields lower by about two basis points on Friday to 4.26%, extending a monthly drop to 23 basis points. That would mark the biggest decline since December. Yields on two-year notes fell about 2 basis points to 4.68%, adding to their June decline. Swaps traders expect around 45 basis points worth of rate cuts for the year, with a quarter-point reduction fully priced in by November.
The so-called core personal consumption expenditures price index — which strips out volatile food and energy items — increased 0.1% from the prior month, marking the smallest advance in six months.
“Data was completely as expected, but by now the bond market knows the Fed’s agenda,” said Thomas Tzitzouris, head of fixed-income research at Strategas Securities. “They want to cut and want to cut soon.”
San Francisco Fed President Mary Daly told CNBC the latest inflation data indicates monetary policy is working, but said it’s too early to tell when it will be appropriate to lower borrowing costs.
The gain in Treasuries came as institutional investors rotated some of their portfolio from stocks after a strong rally in June. The lengthening of duration of US bond indexes at month-end may also lead passive funds to buy more bonds.
Treasuries have soared since the beginning of May as inflation and the labor market showed signs of cooling. The rally helped a Bloomberg gauge of US government bonds all but erase its losses for the year.
Friday’s PCE report offers welcome news for Fed officials as they seek to commence with rate cuts in the coming months — though they’ll likely want to see additional data first. Fed officials recently dialed back their projections for rate cuts this year to just one.
What Bloomberg strategists are saying...
“The PCE inflation data was pretty much perfectly in line with expectations across headline and core, albeit with an unfriendly upward revision to the prior month’s change in core inflation. ... The drop in yields looks like a reflection of the supercore services figure, as well as the muted consumption data.”
Cameron Crise, strategist.
The market has also been recalibrating their expectations for the path of monetary policy ahead. Investors kicked off 2024 by pricing in about half-a-dozen, quarter-point rate cuts for the year, but they’ve since reigned in those wagers to only fully price one.
Some traders in the options market linked to the Secured Overnight Financing Rate, though, on Thursday started to target two rate reductions this year before the December policy meeting and a more dovish policy outlook versus broader market pricing.
“Our house view is that the Fed will deliver the first rate cut in December,” Meghan Swiber, a US rates strategist at Bank of America Corp., said before the data. “We have seen an improvement in services inflation figures recently, but the Fed will want to see more persistent improvement.”
Swiber is already looking ahead to a reading of employment data next week, which she said will be crucial for investors in gauging the Fed’s policy path ahead.
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