As the June U.S. CPI and PPI figures were released, the market's optimism for a downward trend in inflation has been heating up, signaling a new turning point for the U.S. bond market.
This week, the U.S. Treasury yield curve has seen a decline, with the two-year Treasury yield falling by 15 basis points to 4.45%, the lowest level since March. The U.S. Treasury index rose by 0.3%, marking its first positive return this year. In early April, the index had plummeted by 3.4% year-to-date, but it has now erased all of its losses.
The main driver behind this change is the latest inflation data, with the June CPI increase being the lowest in three years. Although the PPI increase announced on Friday was slightly higher than expected, market participants are paying more attention to the decline in consumer confidence. Traders are beginning to embrace the idea of three rate cuts this year, which has fueled a rebound in the bond market.
Sinead Colton Grant, Chief Investment Officer at New York Wealth, stated: "All signs indicate that the Federal Reserve will start cutting rates in September." She mentioned that against the backdrop of a weak June labor market report, the market's reaction to the Consumer Price Index and Federal Reserve Chairman Jerome Powell's recent testimony to U.S. lawmakers both point to this. Powell had indicated this week that the Fed is becoming increasingly vigilant about potential risks to the labor market, while awaiting more evidence of a slowdown in inflation.
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John Madziyire, Senior Portfolio Manager at Vanguard, noted: "Clearly, many people missed out on the 4.75% yield high, and now the market is filled with a fear of missing out (FOMO) sentiment, and there is a greater belief that yields will continue to decline." He believes that the Fed's policies are taking effect and the market is adjusting expectations.
Molly McGown, interest rate strategist at TD Securities, said: "Overall, we believe that interest rates will continue to move lower, entering a phase of easing policy."
However, Mohamed El-Erian, Principal of Queens' College, cautioned market participants to remain vigilant. He pointed out that the upcoming presidential election could complicate the Federal Reserve's decisions. Former President Trump's strong performance in the debate against Biden, along with his proposals for high tariffs and immigration crackdowns, could all contribute to inflation.
In recent market dynamics, the impact of political factors on the bond market has been particularly evident. Since the debate, short-term bonds have outperformed long-term debt, and the steepening of the yield curve reflects the market's concern that Trump's policies could lead to an increased risk premium for long-term Treasuries.
Subadra Rajappa, Head of U.S. Interest Rate Strategy at Societe Generale, said: "Although investors do not have a strong conviction on duration, curve steepening remains the most popular trading strategy."