(Bloomberg) — US government bonds had their best day in months after benign inflation data revived the case for additional Federal Reserve interest-rate cuts.
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The rally slashed Treasury yields across maturities by at least 10 basis points at one stage, with five- and 10-year yields falling as much as 16 basis points. The 10-year, at 4.65%, remained lower by 14 basis points in US afternoon trading, on course for its biggest daily decline since August.
The drop in yields occurred as traders resumed betting on another Fed rate cut by July. The rally erased the impact of strong December employment data released Friday, which sparked a surge toward the highest levels in months as it sowed doubts that policymakers would cut rates at all this year. The 10-year peaked Tuesday at nearly 4.81%, more than a full percentage point higher than when the Fed began easing in September.
“The report gives support to those in the market and at the Fed that the next move by the Fed is still to ease rates,” said Jack McIntyre, portfolio manager at Brandywine Global Investment Management. “Given that inflation is the critical variable, it probably means 10s can start to consolidate between 4.50% and 4.80% for a while.”
The December Consumer Price Index report showed that the rate of increase for core prices slowed for the first time in five months. Along with resilient US economic data, its re-acceleration had suggested that the Fed — which cut rates three times last year by a combined 100 basis points to arrest an increase in unemployment — may have acted prematurely.
Core prices rose 0.2% in December and 3.2% from a year earlier, down from 3.3% in November. The broader consumer price index matched expectations as rose 2.9% in December from a year earlier.
Speaking after the release, New York Fed President John Williams said “the process of disinflation remains in train,” but that the central bank’s 2% price stability goal needs more time. The Fed targets a different inflation gauge that rose 2.4% year-on-year in November. Later Wednesday, Chicago Fed President Austan Goolsbee said it remained possible to tame inflation without causing a recession.
At their last meeting in December, Fed policymakers released forecasts showing they anticipated cutting rates by 50 basis points in 2025. Their previous quarterly forecast was for an additional 50 basis points of easing.
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Leading into the data, flows in Treasury options signaled doubts about a continued selloff. One trade targeted a drop in the 10-year yield back to around 4.6% at a cost of about $45 million. Its mark-to-market value reached about $63 million after the CPI data. Another options trade done less than 30 minutes before the report doubled in value afterward.
The Treasury market lifted government bonds globally, particularly UK bonds, which were already rallying in response to benign domestic inflation data released Wednesday. The UK 10-year yield closed down 16 basis points at 4.73%, its biggest drop in more than a year. Most euro-zone 10-year benchmarks dropped at least 10 basis points.
In the US market, the amount of Fed easing priced in by year end increased by 10 basis points to about 35 basis points, with a quarter-point cut fully priced in by July versus September previously.
Interest-rate strategists at Morgan Stanley recommended that investors position for a cut as soon as March.
Bond traders in recent weeks also cited the prospect of inflationary trade policies under President-elect Donald Trump, who takes office next week, as a reason to be bearish.
“I don’t know how much more we can push Trump policy shocks before we get eyeballs on some details,” said Ed Al-Hussainy, a rates strategist at Columbia Threadneedle Investment.
–With assistance from Edward Bolingbroke.
(Adds Morgan Stanley trade recommendation in third-to-last paragraph, updates yield levels.)
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