This is not the report that the market wanted to see
Alexander Ovchinnikov
Sep 10, 2024Treasury bond yields are rising today after the release of the August inflation report in the US, which investors were eagerly awaiting. It showed, that the annual growth rate of consumer prices sharply slowed down — to 2.53% compared to 2.90% y/y in July.
However, as is known, the essence is in the details, and they clearly did not please market participants. The growth rate accelerated to 0.19% m/m compared to 0.15% in July and –0.06% in June.
Overall, this does not contradict (especially if rounded to tenths) market expectations and to some extent reflects the high base effect. The data indeed deserve attention — primarily from the Fed. Here, Committee members can breathe a sigh of relief and say that they were right to downgrade the status of inflation in their decisions and can now fully focus on ensuring labor market stability.
But the picture must always be viewed as a whole. Thus, the report published at the end of August report on the Fed's preferred inflation indicator — the Personal Consumption Expenditures (PCE) deflator — showed that in July, price growth rates stabilized for the second month in a row. Therefore, the August consumer price report cannot inspire much optimism among investors, even if one blindly considers the drop in inflation to 2.5%.
Moreover, the core index (i.e., excluding food and energy prices) showed an even more upward trend:
- month-over-month, the index increased by 0.28% compared to 0.17% in July and 0.06% in June,
- year-over-year, the index rose to 3.20% compared to 3.17% y/y a month earlier.
Furthermore, if we consider the services sector separately, which, as we remember, forms more than 70% of the US GDP, it not only remains strong but moreover — the price growth rates in it accelerated in August: 0.41% m/m compared to 0.31% in July (year-over-year: 4.93% compared to 4.90% in July).
What This Could Mean for the Markets
Most likely, the Fed will still cut the rate next week for several reasons. But it can be said with certainty that it is not about 50 basis points (b.p.), but only 25. At the same time, the markets still (at least at the moment) had priced in a rate cut of 100 b.p. by the end of the year.
And today, after the release of the report, certain disappointment is clearly evident: the yield on 10-year Treasury bonds increased by 2–3 b.p., and shorter two-year bonds by 4–5 b.p. Thus, the positive spread between these issues on the curve is narrowing, tending back to zero levels.
Obviously, next week before the Fed announces its rate decision could be very tense. But the main thing is that investors should not be misled. Because even if the Fed starts cutting the rate, the slope of the curve may begin to increase not only due to the decrease in the yield of two-year bonds but also due to the increase in the yield of long-term bonds. And there will be many reasons for this, especially after the November elections.
