RATES OVERVIEW
Disinflation drove the initial Treasury rally, with soft U.S. CPI/PPI data pushing the 10Y Treasury yield down to 4.645% and reducing expectations of a September Fed hike. The move remains uneven: long-duration Treasuries face persistent fiscal and supply pressure after the 30Y auction priced at 5.216%–5.24%, while the July deficit reached $432 billion. The market is pricing a Fed pause, not yet a durable easing cycle.
YIELD CURVE
The curve is bifurcated: softer inflation supports the front and intermediate sectors, while heavy supply and fiscal concerns keep the long end elevated. The 20Y yield remains around 5.3%, and the 30Y yield around 5.2%, leaving the curve structurally steep and vulnerable to further bear steepening.
The weak reception for the $35 billion 30Y auction, at yields near 5.24%, confirms that long-end duration requires a larger fiscal and supply premium. Treasury consideration of reducing long-dated issuance may offer temporary relief, but greater reliance on shorter maturities increases future refinancing exposure.
MONETARY POLICY
July’s softer inflation data sharply reduced the market-implied probability of a September Fed hike to roughly 32%–40%, from above 55% one week earlier. The policy signal is a likely pause: nine Fed policymakers reportedly favored holding rates steady versus three supporting a hike, but persistent core PCE inflation above 3% keeps the easing case conditional.
The Fed repricing is dovish but not a pivot. A sustained decline in inflation and weaker labor data could reopen the path to cuts, while stronger employment or firmer core inflation would quickly restore tightening risk. The ECB presents the opposite signal: markets price an 87% probability of a September hike as Spanish inflation rises to 3.9%.
INFLATION SIGNALS
U.S. inflation momentum softened, with headline CPI at 3.4% year over year, core CPI at 2.5%, a 0.1% monthly headline increase, and flat July PPI. Core services inflation declined to 3.0%, its lowest since October 2023, supported by lower airfare, easing wage pressure, and a 2.9% drop in gasoline prices.
The disinflation trend supports lower intermediate Treasury yields and a Fed pause, but it is not broad-based. Core goods prices rose 0.2%, including a 3.5% increase in computer and peripheral prices, while elevated shipping costs and capacity constraints continue to create supply-chain inflation risk. The August CPI/PPI releases are the next major test of whether the current duration rally can persist.
MACRO DRIVERS
- Fiscal supply: The July deficit reached $432 billion, with fiscal-year interest payments at roughly $1.17 trillion. Potential new tax cuts would reinforce the long-end term premium and pressure TLT.
- Growth and labor: July payrolls reportedly fell by 23,000, while labor-force participation declined. Continued labor-market deterioration would support duration; a rebound would challenge the Fed-pause narrative.
- Global policy divergence: Cooling U.S. inflation contrasts with Spain’s 3.9% inflation rate and rising ECB-hike expectations, supporting the euro and highlighting divergent central-bank paths.
- Geopolitical supply risk: Middle East instability and shipping disruptions raise energy and logistics costs, creating a downside inflation risk even as U.S. services inflation cools.
POSITIONING IDEAS
Bullish Duration
- Own intermediate and long duration if upcoming CPI/PPI data remain soft and labor-market weakness persists. A renewed downside surprise in core services inflation or payrolls would push the Fed further toward an easing bias and pull the 10Y below 4.645%.
- Favor the 5Y–10Y sector over the ultra-long end if fiscal supply remains heavy. The front and intermediate curve offer cleaner exposure to a Fed pause, while the 30Y still carries substantial auction and term-premium risk.
- A clear Treasury demand improvement—such as a stronger long-bond auction with a smaller tail—would support adding long-end exposure after the recent selloff.
Bearish Duration
- Stay short or underweight the long end if the next 30Y auction again clears near or above 5.24%, particularly with weak indirect demand. That would signal that fiscal supply is overwhelming the disinflation bid.
- A stronger August CPI/PPI report or a rebound in payroll growth would unwind the sharp decline in September hike odds and pressure the 10Y Treasury back toward recent highs.
- Maintain a defensive stance toward TLT if the White House advances tax cuts without offsetting fiscal measures. The combination of a $1.8 trillion year-to-date deficit, rising interest costs, and heavier issuance would favor further bear steepening and higher long-end yields.