Fed Rate Cuts Continue to Be Favored by Traders After CPI Report

It has been reported that easing inflation pressures has led bond traders to increase bets that interest rates will be cut by the Federal Reserve before the end of this year.

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After consumer prices were released Wednesday, there is a little over the two-in-three chance that the Fed will hike rates by a quarter-point next month, according to the swaps linked to Fed meetings. That probability actually slipped to a little over two in three when swap markets opened on Wednesday. According to swap price calculations, Fed funds rates are expected to move to about a half point lower in December than they are at the moment, indicating a greater degree of easing than anticipated late Tuesday night.

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As a result of fading odds of easier monetary policy by the year's end, Treasury yields saw a rebound as well, which was also triggered by a rally in bets on easier policy. In the aftermath of the CPI report, the yield on two-year notes plunged as much as 15 basis points, and was at around 3.99%, down 3 basis points from 3.59% at the time of publication. There have been a number of factors contributing to the reversal, including comments made by Richmond Fed President Thomas Barkin who said that more work needs to be done in order to get core inflation down. 

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Priya Misra, global head of rates strategy at TD Securities according to a report published by the organization, said that inflation is still high, but it has peaked. The Fed's pressure to keep raising rates will decline if housing starts turn, she said.

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In the Treasury futures market, attention was also focused on a notable bout of activity just ahead of the official release of the CPI data, which prompted some new queries about how traded around well-publicized economic indicators.

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There are fresh questions about leaked US CPI data after big bond moves before it is released

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The year-over-year CPI measure dropped to 5% from 6%. The reading was below economists' expectations of 5.1%. Without food and energy, the core measure was 5.6%, up from the prior month's 5.5%, but in line with economists' expectations.

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Wednesday's US Treasury auction cycle also continues with the sale of $32 billion of 10-year notes along with minutes from the latest Federal Open Market Committee meeting.

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Earlier, the benchmark 10-year yield had reached just 3.34% but has since risen 2 basis points to 3.41%.

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Traders' expectations for Fed policy have shifted sharply all year, which has resulted in large swings in yields Wednesday.

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Vanguard Group Inc.'s senior international economist Andrew Patterson noted that yields have been volatile in recent months. Taking a look at market prices is helpful, but it doesn't tell the whole story. The data today show that core inflation actually rose on a year-over-year basis this month, so the Fed still has a lot to do."

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There aren't many people who are betting on Fed easing this year. Wells Fargo & Co. chief economist Jay Bryson says rate cuts are extremely unlikely if the economy slows only gradually.

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On Wednesday, Bryson said that the inflation rate could stay at 3 to 3.5% if there is a soft landing. The Fed won't be cutting rates by the end of the year if it still needs to get inflation down to 2%. Therefore, I disagree with where the 2-year yield is at the moment.

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