(Bloomberg) -- Traders held on to bets that Federal Reserve officials could raise interest rates at their next meeting in September, pricing in a roughly 40% chance of a move after a tame reading of US inflation.
An in-line reading of the consumer price index helped US Treasuries keep their gains on Wednesday, with the two-year yield — most sensitive to changes in the Fed policy — lower by three basis points to 4.18%. The benchmark 10-year yield was down the same amount to 4.66% ahead of a $42 billion auction of the securities later in the day.
Interest-rate swaps show traders lowered their expectations for a hike in October to about 60%, from roughly 75% a day earlier, after the economic release. The Fed's next move is fully priced in for December.
"While the data should keep September rate hike expectations alive, it also provides little urgency for the Fed to act immediately," said Steve Ryder, Senior Fixed Income Portfolio Manager at Aviva Investors. "Policymakers are likely to place greater weight on the next CPI release and labor market report before making any decision on whether additional tightening is required later in the year."
The rise in Treasuries amid the data follows evidence of bearish positioning in the market ahead of the report. Commodity trading advisers, which seek to profit from momentum across assets, had tripled their underweight bond positions at the end of July and since kept their wagers steady, according to UBS Group AG.
On Wednesday, though, the market's small intraday gains were left intact by the data. For July, the consumer price index, excluding often-volatile food and energy categories, increased 0.2% from a month earlier, according to Bureau of Labor Statistics data. On an annual basis, it advanced 2.5%, matching the slowest pace since March 2021.
Last week, evidence of a weaker-than-expected labor market in July also sparked a rally in bonds as traders dialed back expectations of a rate hike this year. Because the Fed isn't scheduled to vote on interest rates again until September, attention now shifts to the next round of monthly inflation and employment reports for August.
"All Fed meetings in the near future will need to price in the possibility of a surprise, but we continue to think that the Fed will be able to narrowly avoid a hike," said Christopher Hodge, chief US economist at Natixis North America. He cited a gradual drift down toward target inflation, a cooling consumer sector and a more precarious jobs outlook among the reasons.
An annual central bank symposium held in Jackson Hole, Wyoming, at the end of the month will also be watched for any potential hints surrounding the Fed's policy deliberations.
Although Chairman Kevin Warsh has specifically held back on offering guidance to markets about the Fed's policy path since he took the helm earlier this year, that gathering will be an opportunity for him to "fine-tune the inflation message," said Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities.
Brad Conger, chief investment officer at Hirtle & Co. said the firm has been adding exposure in 20-year bonds above 5% "based on our conviction that many forces are militating against broad inflation – most notably real wages which are flat."
Auction Event
The Treasury is slated to sell 10-year securities at 1 p.m. New York time, the second in a trio of auctions this week. A $58 billion three-year note auction on Tuesday was awarded at 4.291%, just off the prevailing yield in the market — a sign that demand slightly exceeded expectations for the highest-yielding auction of the tenor since February 2025.
The 10-year sale will offer a test of appeal among investors as long-dated US government bond yields linger at elevated levels. With inflation running above the Fed's target and swelling budget deficits, some on Wall Street have been demanding more compensation, or risk premium, to own long-end bonds.
Thursday's $25 billion auction of 30-year new issues is expected to draw the highest yield since August 2001.
"It's still hard for yields to come down with outsize deficits, growth running solid, the war and inflation running above the Fed's target," said AmeriVet's Faranello.
--With assistance from Greg Ritchie, Elizabeth Stanton, Cameron Fozi and Ye Xie.
(Updates prices, adds chart and investor voices)
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