Softer Inflation Data Cools Rate Hike Odds, but Yields Climb on Strong Jobs Expectations

Key points

• The 10-year Treasury yield increased by nearly 4 basis points to 5.293%, approaching levels last seen in 2007.
• The 30-year Treasury bond yield rose 5 basis points to 5.644%, marking its highest level since 2002.
• August core Personal Consumption Expenditures (PCE) inflation rose 0.2%, with the annual rate at 3.0%, below the 3.3% forecast.
• Headline PCE inflation increased 0.3% monthly and 3.4% annually, also missing the 3.7% annual forecast.
• The probability of a Federal Reserve rate hike in October dropped from over 80% to 37% following the inflation release, with expectations shifting to December.
• Economists expect the U.S. economy added 84,000 jobs in September, with Friday’s report potentially driving yields higher if data is strong.

Background

This development follows a sustained rise in long-term yields since August, when the 30-year yield approached crisis-era peaks due to high national debt and inflation concerns. In mid-September, the 10-year yield breached 5% again after hawkish Federal Reserve signals and a rate hike to 3.75%-4.00%. By late September, global bond sell-offs pushed the 10-year yield above 5.2%, reflecting investor anxiety over persistent inflation and potential further rate increases.

How outlets are covering it

CNBC emphasizes that despite softer inflation data, yields climbed as traders awaited the September jobs report, suggesting strong economic fundamentals may outweigh disinflation signals. Christopher Rupkey of FWDBONDS noted that the inflation 'fire is not burning as hot as markets expected,' leading to a repricing of rate hike expectations. Conversely, Axios argues that the recent surge in bond yields is primarily driven by rising real yields, indicating strong economic growth rather than inflation fears. Deutsche Bank analysts cited by Axios point out that inflation expectations have barely moved, while real yields have increased significantly, suggesting the bond market is reacting to robust economic strength, evidenced by low unemployment claims and strong corporate profits, rather than rising prices.

Why it matters

The divergence between inflation data and bond yields highlights the Federal Reserve’s dilemma: while inflation is cooling, strong labor market data may necessitate further rate hikes to prevent overheating. This tension affects borrowing costs for consumers and businesses, with higher long-term yields potentially slowing investment and consumption. The upcoming jobs report will be critical in determining whether the Federal Reserve maintains its hawkish stance or pivots, influencing global financial stability and economic growth trajectories.

What to watch

Markets will focus on Friday’s September jobs report, with economists expecting 84,000 new jobs. A stronger-than-expected report could push yields higher and increase the likelihood of a December rate hike. Conversely, weaker data might reinforce the view that inflation is cooling, potentially reducing rate hike expectations. Investors will also monitor core PCE trends and Federal Reserve commentary for signs of a shift in monetary policy.