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Treasuries Sink as Wholesale Inflation Dents Fed Rate-Cut Bets

(Bloomberg) -- Treasuries slumped and traders pared bets that the Federal Reserve will cut interest rates next month after US wholesale inflation jumped by the most in three years.

The yield on two-year notes, which are most sensitive to changes in monetary policy, rose seven basis points to nearly 3.75% Thursday afternoon in New York. The benchmark 10-year yield climbed six basis points, and the dollar gained against a basket of peers.

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The bigger-than-expected increase in the producer price index — which suggests companies are passing along higher import costs related to tariffs — halted a rally in the Treasuries market. Traders who had been piling into wagers on a September rate cut of at least a quarter point and as much as half a point were forced to recalibrate.

“Today’s PPI makes you take a step back and just re-assess,” Priya Misra, a portfolio manager at JPMorgan Asset Management, told Bloomberg Television. “We’re in the midst of a stagflationary shock.”

Interest-rate swaps still point to at least a half point of easing by the Fed over this year’s three remaining policy meetings, but the contracts no longer fully price in a quarter-point cut next month, as they did on Wednesday.

Producer prices increased 0.9% in July, Thursday’s report from the Bureau of Labor Statistics showed, more than four times as much as the median economist forecast. Within the report, services costs increased 1.1%. It followed a largely benign reading on consumer prices released Tuesday.

Fed officials have been weighing mixed economic data ahead of their Sept. 16-17 meeting. Investors are now turning their focus to the Fed’s annual symposium in Jackson Hole, Wyoming, where Chairman Jerome Powell is slated to speak.

President Donald Trump has repeatedly called for Powell to bring down borrowing costs. Treasury Secretary Scott Bessent said Wednesday that economic models show rates could come down by around 150 basis points to reach the so-called neutral rate, at which they neither stimulate nor restrict growth.

What Bloomberg strategists say...

“While yields are rising across the curve after a pickup in July PPI figures, the move appears to be led by mild profit taking after they declined earlier this week.”

— Alyce Andres, Macro Strategist, Markets Live

For the full analysis, click here.

For investors, the consumer price reading was enough to solidify wagers on a quarter-price reduction, with some jumping into bets on an even bigger move.

Despite the reading on producer prices, traders on Thursday added to a position in the Secured Overnight Financing Rate (SOFR) that would benefit from a move of more than 25 basis points.

“PPI is not going to change the overall narrative, but it does take off some of the 50-basis-point risk the marketplace had been thinking about,” said David Robin, an interest-rate strategist at TJM Institutional Services LLC.

Federal Reserve Bank of St. Louis President Alberto Musalem said it’s too early to decide whether to lower rates next month. Fed officials last month left their benchmark interest rate unchanged in a range of 4.25%-4.5%, where it’s been since December.

“For me, it’s too early to say exactly what policy I will be able to support” at the September meeting, Musalem said in an interview on CNBC.

--With assistance from Michael Mackenzie and Edward Bolingbroke.

(Adds comments, updates yield levels.)