(April 10): Bond traders held onto wagers that the Federal Reserve will lower interest rates once this year after data confirmed that US inflation quickened in March as the Iran war led to higher gasoline prices.
Interest-rate swaps on Friday showed traders pricing in a roughly one-in-four chance of a quarter-point rate cut this year, slightly lower than before the data. Treasuries edged lower after the report, with yields up two to two basis points across maturities.
The consumer price index rose 0.9% from February, the most in nearly four years, in large part due to the sharp increase in gas prices tied to the conflict in the Middle East. A measure that excludes food and energy costs — core CPI — increased just 0.2%.
“The CPI data today will not support bond prices as next month’s inflation report will reveal more headaches for investors and the Fed,” Tom di Galoma, managing director at Mischler Financial Group, said.
The March consumer price report offered investors the first tangible glimpse of inflation dynamics since the US attacked Iran at the end of February. Last month’s surge in oil prices propelled Treasury yields sharply higher, before the prospect of a ceasefire — agreed to this week — sparked a reversal in crude and bonds.
See also: Treasuries steady after mixed economic data as oil rebounds
“The ceasefire and negotiations are very important for the market,” said Anders Persson, chief investment officer and head of global fixed income at Nuveen. That means shorter-dated Treasuries are likely to “remain more volatile” as traders price in moving oil prices, “the potential inflation impact and the probability of a Fed cut — or even a hike.”
Before the US attacked Iran in late February, traders had been pricing in more than two quarter-point rate reductions in 2026. They quickly wiped out those expectations and even briefly wagered that the Fed’s next move would be a rate increase. More recently, the market has tilted back towards a potential cut this year.
Treasury yields have swung sharply in recent weeks, as investors oscillated between worries over inflation and growth. After backing off from recent highs, the 10-year yield stood at around 4.30% on Friday, compared to 3.94% at the end of February. The policy sensitive two-year has fallen from last month’s peak of 4% and still remains above the Fed’s current rate ceiling of 3.75%.
See also: Fed minutes show US officials saw two-sided risks from Iran war
On Friday, the ceasefire announced by President Donald Trump earlier this week remained broadly intact across the Middle East, though the Strait of Hormuz was still effectively shut. The US and Iran are scheduled for direct talks in Pakistan over the weekend. Brent was little changed around US$96 per barrel after plunging earlier in the week.
To Nuveen’s Persson, the continued uncertainty is a reason to be cautious on exposure to interest rates through longer-term bonds. “We don’t feel it’s worth the risk,” he said, noting a preference for Treasuries that mature in three to seven years.
In contrast, Dan Carter, senior portfolio manager at Fort Washington Investment Advisors, said he’s taking a bullish position on interest-rate risk and has been adding inflation-linked bonds as hedges. The inflation report on Friday removes pressure on the Fed because it suggests that the price pressures are tied very closely to energy prices — not other domestic risks looming in the US economy, he said.
A stronger-than-expected employment report released last week offered evidence of strength in the labour market, partially soothing growth worries. The Fed cut interest rates three times last year in response to weakness in the job market, then paused the cuts, citing improvement on that front.
That leaves inflation as the focus for bond investors and policymakers, especially as US consumer sentiment fell in recent weeks to a record low. Fed officials have flagged the prospect of higher inflation keeping policy on hold for some time, as their preferred gauge of consumer prices is rising faster than their 2% long-run target. Minutes from their March meeting, released this week, revealed that a growing contingent of officials was concerned that the war in Iran would contribute to rising inflation.
Friday’s report, however, was one of the last major economic data releases before the Fed meets at the end of this month. After next week, Fed officials will also stop making public comments about the state of the economy or policy until their April 29 rate decision, removing some inputs for the bond market.
Uploaded by Evelyn Chan
