Bond Market Maintains Rate-Cut Expectations Despite Hot CPI Data

Fed Rate Cut

Bond traders, steadfast in their belief that the Federal Reserve will initiate interest rate cuts in the coming months, largely shrugged off higher-than-expected inflation readings for December.

Following the release of the consumer price index (CPI) data, which showed a greater-than-anticipated rise in prices, yields experienced initial surges, but these movements were mostly short-lived. Traders continue to anticipate that the Fed will embark on a series of rate cuts totaling more than a full percentage point in 2024, with expectations leaning towards a commencement no later than May. Brief adjustments were made to bets on an earlier start.

The benchmark 10-year note’s yield remained relatively unchanged, hovering around 4.02% after briefly surpassing 4.06%. Shorter-maturity yields, more responsive to Fed actions, erased their increases. The two-year note’s yield declined nearly 5 basis points, narrowing its spread over the 10-year to the smallest in two months.

Despite the higher inflation data, there is a prevailing belief among traders that rates will move lower this year. Sinead Colton Grant, Chief Investment Officer at BNY Mellon Wealth Management, noted, “There is a broader recognition that rates are moving lower this year, and, while there is still going to be volatility, getting exposure to Treasury yields at 4% is attractive.”

The longest-dated Treasury yields remained elevated ahead of a 30-year bond auction, contributing to a steeper yield curve. After the auction, which exhibited near-average demand metrics despite offering the lowest yield since August, yields in the 30-year sector and curve spreads retreated from session highs.

Two-year Treasury yields surpassed 10-year yields by less than 30 basis points, marking the first time since early November. Last year, the two-year yield exceeded the 10-year by over a full percentage point, reflecting confidence in Fed rate increases. However, the gap has since narrowed significantly.

The Fed’s 11 interest-rate hikes since March 2022 had pushed Treasury yields to multiyear highs in October. Subsequent evidence of slowing economic growth and inflation has led the bond market to price in rate cuts exceeding the Fed’s projections. Despite Fed officials indicating that rates are high enough to restore price stability, traders anticipate rate cuts in the coming months.

Consumer prices rose 3.4% from a year earlier in December, with a 3.9% increase excluding food and energy. Despite the bumpy path expected for inflation, traders maintain their outlook for lower rates soon.

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