The $32 trillion US bond market ended a bruising week that pushed yields to multiyear highs, with investors more convinced the Federal Reserve will raise interest rates next week to address sticky inflation.
Policy-sensitive US two-year notes fell and longer-term securities outperformed Friday to leave the 10-year yield at 4.93% after data showed a bigger-than-expected increase in prices excluding food and energy. Investors now see the probability of a Fed move next week at about 90%, with two hikes fully priced in by year-end.
Trading was subdued Friday, capping a week of declines that saw the 10-year Treasury yield climb by the most since May. Even with Friday’s gain, that global benchmark remained in sight of 5%.
While a Fed move next week may help to support inflation-sensitive longer-term securities, the market remains shadowed by worries around ballooning government debt, as well as uncertainty fomented by a more activist Treasury Department and its moves to rein in debt costs.
“A Fed hike in September will help anchor the long end a bit here,” said John Briggs, head of US rates strategy at Natixis Corporate & Investment Banking. “The problem is that sentiment is so bad,” which discourages buyers to come in even as inflation-adjusted yields are looking attractive, he said.
Following Friday’s report, which showed core inflation rose by a greater-than-expected 0.3% in August, yields on two-year notes rose as much as seven basis points to 4.66%, the highest since 2024. The two-year note later retraced some of that move. The 30-year yield fell 2 basis points to 5.34%.
The Treasury market’s relatively muted reaction follows its second-worst day this year, when a surge in oil prices helped drive yields higher. Traders said Thursday’s selloff anticipated the prospect that the CPI data would cement the case for a September rate increase.
The Bloomberg US Treasury Index fell 0.6% Thursday, its worst day since March 20, when rising oil prices helped drive a rout in UK government bonds.
Friday’s reaction “reflects how much rates have moved in recent days,” said Priya Misra, a portfolio manager at JPMorgan Asset Management. “Basically, we think that the market has already priced in a modest hiking cycle.”
Still Above Target
The inflation report suggests inflation is making little progress toward the Fed’s goal amid soaring energy costs from the Iran war, tariffs and the data center build-out. Fed Chairman Kevin Warsh has been reluctant to tip his hand on the central bank’s next move, but in a speech at the Jackson Hole symposium last month he said the Fed would “have work to do” if inflation doesn’t cool “at sufficient speed.”
The data prompted strategists at TD Securities to revise their Fed call, with the firm now expecting the first of three rate hikes in September after previously forecasting the central bank would remain on hold through 2026.
“For the Fed, it is time to put up, or shut up,” Omair Sharif, president of Inflation Insights, wrote in a client note. “You cannot give a speech like you did at Jackson Hole and not support a rate hike at the next meeting. You will either have to back up those words or end up as the boy who cried wolf.”
Treasuries, along with global bond markets, have been hit in recent months as renewed hostilities in the Middle East pushed Brent crude above $100 a barrel and high debt levels remained a concern. Germany’s 10-year yield touched its highest since 2009 after the European Central Bank raised interest rates for the second time since the war broke out in late February.
Despite the rally Friday, the 10-year Treasury yield remain within a shouting distance below the psychologically important 5% level, which it has reached only once — and briefly — since 2007.
‘Clears the Path’
This time, a resilient labor market has kept investors focused squarely on inflation and the prospect that borrowing costs will remain higher for longer. Governor Christopher Waller said last week that his decision at the Sept. 15-16 policy meeting would be “heavily influenced” by this week’s inflation data.
“The report clears the path for the FOMC to hike next week — a move that we expect will be followed by at least an additional quarter-point by year end,” wrote Ian Lyngen, head of US rates strategy at BMO Capital Markets. “The front end cheapened while duration has rallied in outright terms. The price action makes sense — Fed credibility is compressing forward inflation expectations.”
Friday’s rally in longer-dated Treasuries offered some relief for Treasury Secretary Scott Bessent, who has struggled to contain the broader bond selloff ahead of the midterm elections. Expanded Treasury bond buybacks this week did little to counteract the trend.
Bessent has sought to downplay concerns about the rise in yields, saying the Treasury market is in “very good shape,” pointing to robust demand at recent auctions and highlighting US bonds’ performance relative to their global peers. On Thursday, a $22 billion sale of 30-year bonds drew historically strong demand, a sign that higher yields are attracting some buyers.
Keeping long bonds in check may depend, in part, on whether Warsh — who has abandoned the Fed’s long-standing practice of signaling policy moves well in advance — delivers the rate hikes traders are anticipating, investors said. At the July Fed meeting, Warsh’s second since taking the helm — his ambiguity over how he planned to contain inflation helped trigger a sharp selloff in long-term bonds.
“If the Fed were to refrain from hiking after today’s data, it would risk a significant selloff,” Bank of America Corp. strategists including Meghan Swiber wrote in a note. “We suspect policymakers have learned that lesson.”
Written by: Ye Xie and Greg Ritchie — With assistance from Edward Bolingbroke, Michael MacKenzie, Cameron Fozi, and Elizabeth Stanton @Bloomberg
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