Bond traders are tipping off the Federal Reserve on their inflation outlook before the central bank's meeting this week.
The auction last week of 10-year Treasury Inflation-Protected Securities, known as TIPS, drew the weakest demand in nine years. The sale, which some deemed "terrible," trimmed the market-implied expected inflation rate by about four basis points, the most for a single day since mid-June. The market is basically trolling Fed Chair Janet Yellen, who's said it's "premature" to conclude that the underlying trend of prices is falling short of the bank's 2% goal.
After a week that saw the Bank of Japan and the European Central Bank keep their policies largely unchanged, traders are watching for clues that the Fed will ease up on its tightening path after officials meet on July 25-26. The largest impediment for staying on track for three rate hikes in 2017 is the core consumer price index, whose growth rate has dropped to the lowest level since 2015.
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"No one is really expecting inflation to do much, and that leaves the Fed in a bind — what do you do when there's no evidence of any kind for your assertion that inflation is robust?" said Aaron Kohli, a fixed-income strategist at BMO Capital Markets. "It's hard to believe that consistent misses to the downside in core CPI are going to magically lead to better inflation prospects."
The 10-year Treasury yield fell about nine basis points last week, breaking through both the 50- and 200-day moving averages in the biggest drop since April. It's brushing up against the 2.21% level that marks the 61.8% retracement of the rebound from its 2017 low of 2.10% to 2.395% on July 7.
TIPS yields, meanwhile, remain closer to the middle of their 2017 ranges and to comparable nominal yields. Their breakeven rate, which represents expected average inflation over the next 10 years, narrowed to 1.76 percentage points last week, compared with the 2017 high of 2.09 percentage points set in January.
Bloomberg News
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