US Treasuries rallied, driving the two-year yield to the lowest level since 2022 ahead of a closely watched inflation reading that could cement bets on the size of the Federal Reserve’s interest-rate cut this month.
The yield on two-year notes fell as much as five basis points to 3.55%, the lowest since September 2022. An inflation report due later Wednesday is expected to show US consumer prices increased 2.5% in August from a year earlier — down from 2.9% in July.
While the Fed is widely expected to start lowering interest rates at its meeting on Sept. 18, the question is whether it will deliver a half-point cut if incoming data suggests the economy is losing momentum. Traders currently see a roughly 20% chance that it could.
“Clearly the market wants to be long,” said Evelyne Gomez-Liechti, a strategist at Mizuho International. “However, I think we have rallied quite a lot, and unless we get a downside suprise in today’s CPI, I would expect a bit of consolidation around current levels ahead of the Fed meeting.”
Treasuries have staged an impressive rally this year amid mounting evidence that a softer labor market and cooling inflation will pave the way for easier policy. Those expectations were also bolstered by Jerome Powell’s message at Jackson Hole in August, where he said the “time has come” for rate cuts.
The yield on two-year Treasury notes has dropped almost one-and-a-half percentage points from a high in April. The move mirrors gains across bond markets this year, as sentiment over the world’s growth outlook sours. The latest evidence came this week as oil slumped and deflation fears intensified in China.
The average yield on a Bloomberg gauge of investment-grade government and corporate debt has fallen to 3.3%, the least since September 2022.
Still, investors appear undeterred by the low yields on offer. A sale of three-year Treasury notes Tuesday drew record demand from a category of investors that includes overseas accounts. The Treasury will sell $39 billion of 10-year securities later Wednesday and $22 billion 30-year bonds on Thursday.
In total, money markets are pricing more than 110 basis points of cuts through the end of the year and 250 basis points over the next 12 months, which would bring the upper bound of the Fed funds rate to 3%.
“The public debate may begin to shift toward a possible dearth of inflation, which would stand to usher in a longer-run bullish trend in fixed income,” Rabobank strategists Richard McGuire and Lyn Graham-Taylor wrote in a note.
Indeed, recent activity in options market shows that traders are positioning for even swifter easing than what is implied by the swap market. Pricing there shows that 150 basis points of cuts are expected by the Fed’s January decision, which would require at least two half-point cuts over the next four scheduled meetings.
Investors are also keeping a close eye on the repercussions of the first US presidential debate between Democrat Kamala Harris and Republican Donald Trump on Tuesday. The two candidates sparred over the state of the economy and US-China relations, and market reaction has been limited so far.
“With Harris perceived to have performed relatively well in the debate, we believe the market will be marginally less concerned about potential Trump policies that would risk stalling the US disinflation trend and potentially slow global growth,” Nomura strategists led by Craig Chan wrote in a note.
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