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Treasuries rally as data backs the case for a September rate cut

The US Treasury Department in Washington, DC. (Chip Somodevilla/Photographer: Chip Somodevilla/G)

(Bloomberg) -- Treasuries are rising at the end of a volatile week as the Federal Reserve’s favorite inflation gauge cemented traders’ expectations for an interest-rate cut in September.

The advance pushed yields lower across the curve on Friday, with two- and 10-year yields down by about five basis points to 4.38% and 4.2%, respectively. US government debt is on pace for a third-straight month of gains, according to data compiled by Bloomberg, the best streak since mid-2021.

Interest-rate swaps show traders expect the US central bank to keep rates steady next week, then kick off an easing cycle at the September gathering. In all, they are fully pricing in at least two quarter-point reductions this year.

A rate cut in September “seems on track,” and there’s “nothing to upset the apple cart,” said Lindsay Rosner, head of multi-sector fixed income investing at Goldman Sachs Asset Management. “We’ve been advocating for extending duration for some time now. The data has been reinforcing” it, she said.

A year after the Fed pushed the benchmark rate to a two-decade high, inflation and the labor market are finally showing signs of cooling. The Fed’s preferred measure of underlying US inflation rose at a tame pace in June and consumer spending remained healthy, according to data released on Friday. Rosner called it a “super-tame and in-line economic print.”

US consumer sentiment, meanwhile, eased in July to an eight-month low as high prices continued to weigh on attitudes about personal finances.

The economic releases tee up next week’s US central bank gathering that has already garnered attention from well-known prognosticators. In separate Bloomberg Opinion columns, former New York Fed president William Dudley said policymakers should reduce rates at the July gathering, and Mohamed El-Erian warned of a “policy mistake” if the central bank keeps rates too high for too long.

What Bloomberg strategists say...

“Bond investors can continue to be bullish given PCE figures suggest a soft landing. With 2.5% PCE precipitating as many as three rate cuts this year, that also leaves the curve steepener trade intact, with less than 20 basis points left for the curve to uninvert from two to 10 years.”

— Edward Harrison,”The Everything Risk” newsletter. Read on MLIV.

Shorter-term Treasuries led the rally in recent days, extending the recent trend of pushing the yield curve steeper. Two-year yields have fallen 12 basis points this week, and touched 4.34%, the lowest since February.

In comparison, 10-year yields fell four basis points this week, while 30-year yields were little changed at 4.45%. The tepid bids in long-term bonds — a traditional safe haven — stand out in a week when risky assets wobbled and wiped out $2 trillion in stock market valuation globally.

After staying upside-down for more than two-years, the yield curve is becoming less inverted. At about 4.4%, the two-year yields are only 18 basis points higher than 10-year rates, compared with about 50 basis points a month ago.

The so-called steepener trade has quickly became as the favored wager in the bond market since Donald Trump emerged as the favorite to win the presidential election in November. The idea is that the Republican candidate may impose tariffs and tax cuts, a policy mix that may fan inflation and deficit concerns.

While his odds in betting markets have slipped since President Joe Biden ended his reelection bid to endorse Kamala Harris as the Democratic nominee, the trade still has momentum as rate-cut expectations build up and pushed short-term rates to outperform.

“We already start to see 10-year Treasury decoupling from the Fed rate cut expectation,” said Tracy Chen, portfolio manager at Brandywine Global Investment Management. “This means the bond supply pressure starts to wear down 10-year pricing. We believe curve steepening will play out from here.”

Interest-rate swaps have priced in five quarter-point cuts in the next six policy meetings after the July gathering. It was reminiscent of the episode earlier this year when traders bet on rate cuts aggressively, only to be disappointed as the economy showed resilience. The aggressive rate pricing has left some investors reluctant to chase the bond rally.

“The market seems to be in a rush to price in too many cuts,” said Subadra Rajappa, head of US rates strategy at Societe Generale. “That said, it’s hard to fade the momentum as the market is likely to over-react to weakness in the data. I’d be a bit more cautious and neutral ahead of a busy data week.”

(Updates with weekly moves, comments and context.)

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