(Bloomberg) -- Traders added to wagers that the Federal Reserve will cut interest rates by another quarter point next month after in-line inflation data, spurring gains for Treasury debt.
The rally trimmed yields on two-year notes, more closely tied than longer tenors to Fed rate decisions, by as much as 10 basis points to 4.24%. Swaps traders boosted to about 80% the probability that the Fed will cut rates again on Dec. 18, up from around 56% earlier Wednesday. Through June, they priced in just over 60 basis points of cumulative reductions.
The October consumer price index data quelled concern about halting progress toward lower inflation even before President-elect Donald Trump takes office in January. Bond traders in the weeks leading up to the Nov. 5 election — which pollsters said was too close to call — had lowered their expectations for additional Fed rate cuts over the coming year.
“Bang in-line core inflation leaves the Fed on track to cut rates in December,” said Lindsay Rosner, head of multi-sector fixed income investing at Goldman Sachs Asset Management. “After a run of unseasonably hot autumn data, today’s number cools fears of an imminent slowdown in the pace of rate cuts.”
Longer-dated rates declined less, then rebounded amid the latest surge in new corporate bond sales. Yields remain near the highest levels in months, reached in the week since the election of Trump, whose tax policies have been predicted to be inflationary. Republicans also won control of both chambers of Congress, news networks said Wednesday after the final House races were called, facilitating implementation of the policies.
Consumer prices rose 2.6% year-on-year in October overall and 3.3% excluding the volatile food and energy categories. Both figures matched the median forecasts of economists in a Bloomberg survey. The figures underscore the slow and frustrating nature of the battle against inflation, which has often moved sideways — sometimes for months at a time — on its broader path down.
“The biggest news we are interested in is the fiscal adjustment and what that is going to look like” under the new administration, said Frances Newton Stacy, economic strategist and wealth manager at Scarlet Oak Financial Services. “Bonds are having a hard time pricing all this in.”
Before the CPI data, traders had been piling into bets that the Trump agenda would lead to further losses in Treasuries. Open interest — the number of contracts in which traders have positions — in Treasury futures suggests an increase in new hedges for higher yields since the election.
Wednesday’s Treasury futures activity after the data included a couple of large block trades in the five-year note contract that appeared to contribute to the rally.
“We maintain our call for a 25-basis-point cut at the December FOMC meeting, but believe that it could still be a close call, given there will be one more payroll report and CPI report,” Barclays economists Pooja Sriram wrote in a note with her colleagues on Wednesday. Last week, the team revised upward their baseline CPI forecast for 2025 to incorporate Trump’s proposed policies, mainly reflecting plans for increased tariffs.
Fed policymakers have been delivering the message that — after their initial half-point rate cut in September and a quarter-point reduction on Nov. 7 — future moves are contingent on inflation continuing to show improvement.
Officials echoed that after the CPI data were released Wednesday. Minneapolis Fed President Neel Kashkari, speaking on Bloomberg Television, said he views inflation as “heading in the right direction” but the December decision would take into account future economic data.
Dallas Fed President Lorie Logan said the Fed should “proceed cautiously at this point” because of the risk inflation remains elevated. Kansas City Fed President Jeff Schmid on Wednesday sounded a note of caution about how much more the US central bank will need to lower interest rates. St. Louis Fed President Alberto Musalem said the central bank is within sight of its inflation and employment goals.
Trump’s agenda — which includes tax cuts — is seen expanding the federal budget deficit, requiring increased US debt issuance. Investors are accordingly demanding higher Treasury yields as the price of providing additional financing. While some have predicted 10-year yields will return to the 5% as Treasury supply increased, not all are convinced.
Stephen Jen, Eurizon SLJ’s chief executive officer, said the US 10-year Treasury yield is already too high, and he sees 3.5% as fair value. He wrote that consensus Trump trades are at risk of faltering as the incoming administration’s policies might produce more positive results on the fiscal front than markets are assuming.
What Bloomberg strategists say...
“Treasury moves in the coming months are going to come in reaction to economic and inflation data influenced by past fiscal and monetary policy — from as distant as 12 or 18 months ago. Any inflation from the future Trump administration’s policies won’t be felt until well into the future. In the here and now then, the question is whether the Fed has helped to stick the soft landing, and whether, having done so, has allowed inflation to remain elevated well above target. This report doesn’t answer that question.”
— Edward Harrison, “The Everything Risk” newsletter. Read more on MLIV.
Many of Trump’s ideas “are pro-growth policies, though having said that, the wild card is tariffs,” said Earl Davis, head of fixed income and money markets at BMO Global Asset Management in a telephone interview. Investors are “still trying to find how much risk premium is needed now – and the market is saying it’s definitely not less.”
Davis expects increased debt issuance next year and favors buying inflation-protected over so-called nominal Treasury debt. The 10-year TIPS yield is about 2.1%, up from as low as 1.5% in mid-September, a period in which the nominal 10-year yield climbed about 80 basis points as inflation expectations increased.
--With assistance from Kristine Aquino, Edward Bolingbroke and Anchalee Worrachate.
(Adds comment from Fed’s Musalem, bank economist and updates yield levels.)
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