Treasuries hold recent gains as inflation gauge stabilizes

US Treasuries retained most of their recent gains as anticipation of Federal Reserve interest rate cuts held firm after the central bank’s preferred gauge of inflation matched economist estimates.

Yields were mixed across tenors following Friday’s release of July personal income and spending data, with short maturities little changed after falling from session highs while longer-dated yields were several basis points higher on the day. The report embeds price indexes for personal consumption expenditures, or PCE, including the inflation rate that Fed policymakers aim to keep at around 2%.

That rate was unchanged at 2.6% in July, while the core PCE price index — which includes excludes food and energy — rose 2.9% from a year earlier, compared with 2.8% in June. 

The report left intact expectations that the Fed will cut interest rates twice this year, beginning as soon as next month, in response to signs of a softer labor market even as inflation remains above the 2% target. 

“Core PCE was mild enough that a Fed cut is still the most likely outcome” for September, said Bryce Doty, a bond fund manager at Sit Investment Associates. “The two-year yield is so low it’s telegraphing what the Fed is going to do for sure.”

Swap contracts that predict Fed rate decisions are pricing in about 20 basis points of easing for Sept. 17, about 80% of a quarter-point rate cut, and a cumulative 55 basis points by the end of the year.

Rate-cut expectations rocketed higher in early August after employment data registered a sharp slowdown in job creation through July. A poor August jobs report on Sept. 5 “might put a 50-basis-point cut on the table” for September, Doty said. 

Two-year yields declined to session lows after revisions to the University of Michigan’s August consumer sentiment survey showed lower expected inflation rates than the preliminary findings did. 

Fed Governor Christopher Waller, who along with Governor Michelle Bowman dissented from last month’s decision to leave rates unchanged in favor of cutting them, in a speech last night said he supports a September rate cut and anticipates additional reductions over the coming three to six months.

Two- to five-year Treasury yields, more sensitive to Fed rate changes than longer maturities, touched the lowest levels since early May this week, partly in reaction to efforts by US President Donald Trump to install new central bank policymakers committed to monetary easing. Created via a Tuesday auction at a yield of 3.641%, the latest two-year note rallied to 3.61% the next day, and traded at around 3.62% Friday.

Most of this week’s drop in short-maturity yields “was driven by the news from President Trump calling for Fed Governor Cook to be fired and the question of Fed independence going forward,” said Molly Brooks, US rates strategist at TD Securities. Trump is attempting to unseat Fed Governor Lisa Cook based on unlitigated charges of mortgage fraud. Cook is challenging the action in hearing that began at around 10 a.m. in Washington.

Benchmark yields other than the 30-year declined in August, leading the Bloomberg Treasury Index to a gain of more than 1% through Thursday. The 30-year is higher on the month, partly on concern about inflation arising from politically motivated monetary policy. Also, 30-year yields have risen globally, with those of Germany, France and Japan reaching multiyear highs.

Longer-maturity Treasury yields rose Friday in part because the personal income and spending data show resilience on the part of consumers that’s unlikely to persist while interest rates remain high, Doty said. 

Also, corporate bond underwriters expect a seasonal surge in supply next week — traditionally one of the market’s busiest weeks of the year. Hedges to protect anticipated offerings from rising yields can involve sales of Treasuries or paying in interest-rate swaps, a negative for the market.

The Treasury market may benefit Friday from bond-index rebalancing taking place at 4 p.m. New York time. The month-end changes have the potential to create demand for bonds entering the benchmarks from index funds and other passive investors. While dealers prepare for the event, limiting its market impact in many cases, the biggest rebalancings are on the last trading days of August, November, February and May, when the largest amounts of new Treasury debt are sold.