Yields move up after CPI poses no risk to 25 bp Sept cut

By Alden Bentley

NEW YORK (Reuters) - U.S. Treasury yields popped higher after a July U.S. consumer inflation reading came in as benign as predicted, smoothing the way for a Federal Reserve interest rate cut next month of at least 25 basis points, although a more aggressive 50 bps cut looks less likely.

The odds of a rate cut at the Fed's Sept. 17-18 policy meeting had been nearly split between half a percentage point and 25 bps before the Labor Department reported its Consumer Price Index increased 0.2% last month after falling 0.1% in June, and increased 2.9% year-on-year, less inflationary than June's 3.0% advance. Futures moved slightly in favor of a 25 bps cut after the report, with odds at 58.5% according to LSEG calculations.

Economists polled by Reuters had forecast the CPI increasing 0.2% on the month and 3.0% over 12 months.

Yields clawed back some of what they lost on Tuesday after the government reported a mild increase in July producer prices.

"The market is thinking that inflation is a little bit more sticky than the Fed was expecting, and they're penciling out some of that 50 basis point pricing,” said Gennadiy Goldberg, head of U.S. rates strategy at TD Securities in New York.

“Other than that, I think this really checks the box for the Fed to go in September. And of course, the big question for the market is going to be 25 or 50, and I suspect that's going to be determined over the next couple of weeks.”

Traders are still pricing in a full percentage point of easing from the current 5.25% to 5.5% fed funds rate by year-end. The policy rate has not changed since July 2023 after the Fed hiked from zero starting in March 2022.

The yield on the benchmark U.S. 10-year note was off 0.2 basis point from late Tuesday at 3.852%, but about 2 bps higher than where it stood before CPI. The 2-year note yield, which typically moves in step with interest rate expectations, was up 3.7 basis points to 3.9787%.

The 30-year bond yield fell 2.6 basis points from late in the previous session to 4.1403%.

The closely watched gap between yields on two- and 10-year Treasury notes, considered a gauge of growth expectations, was at negative 12.9 bps, slightly more inverted than its reading of -9.2 bps late Tuesday. An inverted yield curve is generally seen as pointing 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 showed a more normal upward slope since July 2022.

(Reporting by Alden Bentley; editing by Jonathan Oatis)