Bond Traders See Quarter-Point Cut Next Month as Inflation Ebbs

(Bloomberg) -- Bond investors reinforced their bets that Federal Reserve officials will cut interest rates by a quarter-point in September as US inflation continues to ebb.

Traders are pricing in 32 basis points worth of easing at the Fed’s September gathering, trimming their expectations from a day earlier — and lowering the odds of a half-point cut at the next central bank meeting to about one-third. Treasuries mostly gained on Wednesday, pushing yields lower beyond the five-year sector.

Ebbing inflation data on Wednesday is “confirmation the inflation problem is whittling away,” David Kelly, chief global strategist at JPMorgan Asset Management told Bloomberg Television. A CPI figure “close to expectations is a case of sell the news — and that’s going on in the bond market.”

The yield on policy-sensitive two-year Treasuries rose to 3.95% on Wednesday, while yields out the curve from five years were steady to lower — led by a four basis point drop in 30-year bond yields.

Open interest, or the amount of risk taken on by futures traders, was consistent with bond traders positioning for gains in the Treasury market. They’d added to those bullish bets on Tuesday as data showed producer price index rose in July by less than forecast.

In trading on Wednesday, flows in options linked to the Secured Overnight Financing Rate — which closely follows the central bank’s policy path — reflected traders unwinding bets on half-point rate cuts. Traders appeared to adjust other dovish wagers as pricing in the swaps market favored a quarter-point move over a half-point cut.

Those moves came after the so-called core consumer price index — which excludes food and energy costs — increased 3.2% in July from a year ago, still the slowest pace since early 2021. That was largely in-line with economists’ expectations, keeping the Fed on track to lower borrowing costs soon.

Traders are still pricing in just over 1 percentage point worth of rate reductions in 2024, with three Fed policy meetings remaining this year. In recent sessions, market pricing had shown a split on the outcome of either 25 or 50 basis points worth of rate reductions next month.

The data “cleared the way for a 25 basis point cut in September, while not completely shutting the door on the chance of a 50 basis point cut,” said Lindsay Rosner, head of multi-sector fixed income at Goldman Sachs Asset Management.

Weekly jobless claims and retail sales data on Thursdays will offer the next potential clues for traders as they focus on the scope of easing ahead. They’ll also scour Fed Chair Jerome Powell’s comments at the annual central bank symposium held in Jackson Hole, Wyoming, later this month and the next US labor report in early September.

At Jackson Hole, “they may push back a a little bit on the more-negative sort growth scenario,” said Neil Sutherland, portfolio manager at Schroder Investment Management.

“We’ve definitely been seeing some more softness in the labor market,” he said. As the market debates the size of a likely Fed cut in September, “the labor market will give us a little bit more clarity.”

On Tuesday, Atlanta Fed President Raphael Bostic said he’s looking for “a little more data” before supporting a reduction in rates, emphasizing he wants to be sure the US central bank will not have to change course once it begins cutting.

--With assistance from Edward Bolingbroke and Carter Johnson.

(Updates pricing, adds quote.)