(Bloomberg) — Traders all but abandoned expectations for a Federal Reserve’s interest-rate cut before July, and Treasury yields soared, after a report showed that inflation remains sticky in the US.
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Swaps contracts referencing the US central-bank policy meetings — which as recently as mid-January fully priced in a rate cut in May and 175 basis points of easing by the end of the year — were roiled. The odds of a May cut dropped to about 36% from about 64% before the inflation data, with fewer than 100 basis points anticipated this year. The two-year Treasury yield rose as much as 16 basis points to 4.63% and remained higher by more than 12 basis points.
Bond investors have been counting on Fed rate cuts to put an end to the losses that accumulated over the past two years, during which the central bank tightened policy by more than five percentage points. But Fed policy makers have said they need to see additional evidence that inflation is returning to their 2% target rate before embarking on cuts.
“Inflation was surprisingly elevated in today’s report,” said Phillip Neuhart, director of Market and Economic Research at First Citizens Bank Wealth. “This makes the Fed’s job harder,” he said, adding “we continue to expect the Fed to cut the federal funds rate later this year, but today’s report casts doubt on the first cut being in the near term.”
Even a June rate cut was in doubt after the data, though as the dust settled traders appeared once again to consider it the likeliest outcome.
Treasury rates shot higher led by short maturities, which are most sensitive to Fed policy, though all reached the highest levels this year. Thirty-year bond yields jumped as much as 7 basis points to 4.45%. The benchmark 10-year yield climbed 11 basis points to 4.29%.
The action wasn’t confined to the US. Trading was so volatile in the minutes after the release that Eurex, the leading exchange for German government bond futures, briefly halted transactions in five- and 10-year contracts. German bonds swung to losses, with yields rising as much as 10 basis points from a low of 2.32% just before the data was published.
Earlier in the day, traders pared bets on Bank of England cuts, pushing the timing of the first expected reduction to September from August after data showed UK wages rose more than expected.
Read more: US Inflation Tops Forecasts in Blow to Fed Rate-Cut Hopes
“It’s not good news,” Jay Bryson, Wells Fargo & Co. chief economist, said of the CPI figures on Bloomberg Television. Still, “the Fed is not going to make a decision based on one data point. And May is still a long ways away.”
The consumer price index data released Tuesday showed less deceleration than economists had estimated, with the rate slowing to 3.1% and the core rate, which excludes food and energy, holding steady at 3.9%.
Fed policymakers favor an inflation metric known as the personal consumption expenditures price index, which is computed differently than CPI. The PCE has been trending much closer to the Fed’s 2% target.
Going into Tuesday’s inflation report, many investors were betting that the US bond market was nearing a turning point with a clear path unfolding to lower yields.
One trader has paid a premium of around $1 million on futures options betting the 10-year yield will fall below 3.88% by the end of next week. A similar wager in the five-year tenor placed Monday is targeting a move to around 4%, from 4.13% currently.
Still, US Treasuries remain attractive for “income and diversification” purposes, David Kelly, chief global strategist at JPMorgan Asset Management, said on Bloomberg television Tuesday. “You do not buy bonds for capital gains,” he said. “There’s nothing wrong with 4.25% on a 10-year Treasury given an inflation rate that is slowing coming down to 2%.”
–With assistance from Alice Gledhill, James Hirai and Constantine Courcoulas.
(Updates rates throughout.)
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