Treasury yields declined across the board today after the latest May PCE core inflation report showed a smaller increase than anticipated. The core PCE, the Federal Reserve's preferred inflation gauge, rose by 0.2% month-over-month, falling short of the consensus expectation of 0.3% and a slight tilt towards 0.4%. This benign inflation data led traders to scale back their bets on a significant interest rate hike from the Fed in the coming months, particularly for the September meeting.
The dovish shift in market expectations for Fed policy was evident in the yield curve, with a significant flattening observed in the 2Y10Y US yield curve and 10-year Bunds falling below the 2.90 mark. While Fed Chair Kevin Warsh reaffirmed his commitment to controlling inflation last week, and some officials like ECB's Schnabel warned against complacency, the latest inflation figures seem to offer some respite. Futures markets are now indicating a reduced probability of a September rate hike, a notable change from the 68% probability assigned last week.
Adding to the downward pressure on Treasury yields were easing geopolitical tensions and a significant drop in oil prices. The reopening of the Strait of Hormuz, coupled with progress in US-Iran peace negotiations, drove Brent crude down to around $72 per barrel, nearing pre-conflict levels. This reduction in oil prices alleviated concerns about inflationary pressures, further supporting the case for a less aggressive Fed monetary policy. The US 10-year Treasury note yield, which had already fallen to a six-week low of 4.4% earlier this week, continued to decline.
Despite the overall trend towards lower rate hike expectations, the general sentiment remains that the Fed will likely maintain a hawkish tone. Traders are now awaiting additional economic data, including first-quarter GDP figures, May personal income, preliminary durable goods orders, and weekly jobless claims, to further evaluate the outlook for interest rates. The market is currently pricing in about a 60% chance of a quarter-point Fed hike by December, down from about 80% just a week prior.
