Yields lower after tame producer inflation data, focus turns to CPI

By Alden Bentley

NEW YORK (Reuters) -U.S. Treasury yields slipped on Tuesday after the release of tame producer price data, which looks unlikely to divert the Federal Reserve from an easing path, with Wednesday's consumer prices report set to fill out the picture.

The July Producer Price Index increased a less-than-expected 0.1%, after rising 0.2% in June, the Labor Department said, as a rise in the cost of goods was tempered by cheaper services. In the 12 months through July, the PPI increased 2.2%, backing down from a 2.7% rise in June.

Vail Hartman, U.S. rates strategist at BMO Capital Markets in New York, said CPI and PPI are not highly correlated and the market took the data in stride. PPI should not throw the Fed off course because parts of it contribute to the Personal Consumption Expenditures price index, which the Fed relies on most to guide policy, he said.

"Just looking at the PPI data and specifically the elements that feed into core PCE, I don't think there was anything truly alarming and, from a broader perspective, I think the data conforms with the disinflation narrative."

Slowing inflation and a cooling labor market have led financial markets to anticipate that the Federal Reserve will start its easing cycle in September. With inflation behaving and the unemployment rate surging to near a three-year high of 4.3% in July, an interest rate cut of 50 basis points from its current 5.25% to 5.50% range cannot be ruled out.

Futures markets reflect odds of about 54% that the Fed will cut 50 bps against 46% for a 25 bps cut, a flip around from late Monday. Traders are pricing in a full percentage point of easing by year-end.

Bond yields fell sharply to their lowest in more than a year in the wake of the surprising jump in the unemployment rate and weaker-than-expected payrolls increase reported last Friday.

They have recovered somewhat but remain under pressure amid concerns that confidence of a soft landing may be excessive and that a recession could be in store.

The yield on the benchmark U.S. 10-year note was down 4 basis points at 3.869%, almost 3 bps below where it stood before PPI. The 2-year note yield, which typically moves in step with interest rate expectations, fell 4.8 basis points to 3.9668%, about 3 bps of which came after the report.

The 30-year bond yield fell 2.5 basis points from late in the previous session to 4.1729%.

The closely watched gap between yields on two- and 10-year Treasury notes, seen as an indicator of economic expectations, was at negative 10 basis points, slightly steeper, or less inverted, than its reading of -11.7 bps late Monday. An inverted yield curve is generally seen as a pointer to a recession.

Hopes of an aggressive 50 bps easing in September briefly shifted the gap between 2- and 10-year yields to a positive 1.5 bps last week, the first time the curve had shown a more normal upward slope since July 2022.

(Reporting by Alden Bentley; editing by Jonathan Oatis)