Following the latest inflation data and a surge in oil prices, bond traders are now anticipating two Federal Reserve interest rate hikes before the end of the year. Expectations for a 25 basis point hike at the Fed's September 15-16 meeting have risen to roughly 70%, up from 62% earlier. This sentiment is fueled by producer price index (PPI) data, which, while in line with monthly expectations, showed a 5.4% annual increase through August, exceeding the 5.3% consensus and July's 4.8% rise. Energy prices also climbed by 4.2% in August after two months of decline.
The market's focus on inflation has been amplified by a significant rally in oil prices, with both Brent and WTI benchmarks trading over $100 a barrel. This surge is attributed to heightened attacks on shipping amidst the ongoing Iran war, raising concerns about disruptions to already tight energy supplies. President Donald Trump's comments on the Iran war have further contributed to these worries. Analysts suggest that even though the PPI headline met consensus, some components feeding into core Personal Consumption Expenditures (PCE) were stronger than anticipated.
U.S. Treasury yields have reacted sharply to these developments. The yield on benchmark 10-year notes increased by 10.93 basis points to 4.946%, marking its highest level since October 2023. The 30-year bond yield rose by 7.27 basis points to 5.3587%, reaching its highest point since June 2007. Furthermore, the 2-year note yield, sensitive to Fed interest rate expectations, climbed by 13.33 basis points to 4.56%, its highest since July 2024. The yield curve between 2- and 10-year Treasury notes also flattened to 38.4 basis points.
Adding to the market's dynamics, the U.S. government conducted a bond buyback operation of $5.2 billion, less than the $6 billion cap and half of the $10.5 billion offered. However, a $22 billion sale of 30-year bonds saw very strong demand, with the debt selling at a high yield of 5.308%, more than 2 basis points below pre-auction trading. The bid-to-cover ratio for this auction was 2.61 times, the highest since February, with strong interest from overseas buyers noted by market strategists. The upcoming August consumer price index report on Friday is expected to be the next major indicator for inflation expectations.
