Traders Place Higher Bets on Fed Rate Reduces Year-End, After CPI

(Bloomberg). Bond traders bet that the Federal Reserve will reduce interest rates before the year ends after a report indicated an improvement in inflation pressures.

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The Swaps that are linked to Fed meetings show an approximately 80% probability of a quarter point hike next month. This is based on consumer-price data which was released Wednesday. After that, the probability fell to just over two in three earlier. Swap pricing also indicated that December’s effective fed funds rate was expected to be half of its current level at 4.83%. This is an even deeper degree than what was predicted late Tuesday.

Bets on an easier year-end policy did not fall from the extremes of earlier in session. This triggered a rebound in Treasury yields. After plunging up to 15 basis points following the CPI report, two-year yields were little affected at 4.02%. Thomas Barkin, Richmond Fed president, commented on the reverse. He said that core inflation needed to be brought down and suggested more work was needed.

“Inflation is still high, but it has peaked and if shelter is turning, some of the pressure on the Fed to keep hiking will decline,” said Priya Misra, global head of rates strategy at TD Securities.

The Treasury futures market also saw a noteworthy bout of activity right before the official publication CPI data. This raised new questions about trading around important economic releases.

New Questions about Leaks: Big Bond Moves before US CPI Data

From 6%, the year-on-year CPI increase fell to 5%. That was below economist’s estimates of 5.1%. The core measure, which strips food and energy, came in at 5.6%. This is higher than the previous month’s reading of 5.5% but within economist estimates.

Next, bond traders will examine the minutes from the Federal Open Market Committee meeting at 2:05 p.m. in Washington. The US Treasury auction continues Wednesday with the sale of $32 Billion of 10-year notes. The sale saw moderate demand, with the yield at the sale about 2.1 basis point higher than that of the issued security before auction bidding was completed. While this so-called auction tail is a negative sign on demand, other measures — including the bid-to-cover ratio were “decent”, according to Ben Jeffery at BMO Capital Markets.

Treasury 10-Year Auction Tails Despite Low Prices Before Sale

After the auction, benchmark 10-year yields capped a rise that began after a post-CPI release swoon which saw the rate drop to as low as 3.3%. At 1:25 PM New York, the yield was at 3.45%. This is an increase of around 2 basis points.

The swings in yields Wednesday were in line with the outsized volatility in the Treasury market that has been seen all year as traders’ outlook for Fed policy has shifted sharply.

“Yields have been more than a bit volatile recently,” said Andrew Patterson, senior international economist at Vanguard Group Inc. “Focusing on market pricing is helpful but doesn’t present the whole story. And today’s data shows core inflation actually picking up this month on a year-on-year basis and that says to us that the Fed still has more work to do.”

Many people will not be taking part in the Fed easing wagers this year. Rate cuts are especially unlikely in 2023 if the economy proves to slow only gradually, said Jay Bryson, chief economist at Wells Fargo & Co.

“If we have a soft landing, I could see the inflation rate getting stuck at 3 to 3.5%,” Bryson said on Bloomberg Television. If the Fed still needs to get inflation “back down to 2% you are not going to see rate cuts by the end of the year. So, I have a bit of a disagreement with where the 2-year yield is right now.”

–With the assistance of Mark Tannenbaum and Michael Mackenzie

(Additional detail about 10-year Treasury auction results.

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