The debate over whether the Fed would raise rates again this year just quieted.
For weeks, traders debated whether the Fed chair would be forced to push rates higher. This week's inflation data helped cool that argument, and lower oil prices added confidence that inflation has peaked.
The bond market's advance pushed yields down by roughly six basis points across various maturities. A basis point is one-hundredth of a percentage point, so the move was small but telling.
Short-term rate contracts now imply fewer expected hikes, and the chance of a September hike sits below 40%.
Derivatives betting on a smaller amount of tightening drew notable demand, especially March contracts. The December futures contract had just priced in a quarter-point hike just days ago; now it points to roughly 23 basis points of tightening, leaving a hike on the table but not locked in.
Thursday's report showed producer prices decelerated in July, and the prior day's consumer-price report showed prices cooling for the second month in a row. Last week's weaker-than-expected July jobs report had already led traders to cut bets that the Fed chair and his colleagues would raise rates.
Oil helped too. Crude has been a major influence on Treasury yields since the U.S. strike on Iran in late February, which caused a supply disruption. On Thursday, benchmark crude briefly slid over 3.5% as traders weighed signals on the ongoing conflict. It later trimmed that loss, but the message landed: cheaper oil takes pressure off inflation.
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The U.S. Treasury sold $25 billion of new 30-year bonds, and the auction drew the highest yield for that maturity since 2001.
The 30-year sector declined less than other maturities. That gap signals demand was slightly weak, but the auction still found buyers.
Treasuries gave back some gains as the 1 p.m. cutoff for 30-year bids approached. Those yields ended about five basis points lower after falling nearly eight earlier in the day.
There is also a pattern working in the auction's favor. A strategist at Mischler Financial Group notes that for August 30-year new issues over 17 years, 13 rose by the next session's close. History, in other words, is on the buyer's side.
The market's no-hike bet is not unanimous at the Fed itself. Three officials, with Cleveland Fed President Beth Hammack among them, voted no on last month's rate-hold decision, arguing for a hike instead.
Hammack said Thursday at an Ohio event that rates still need to rise because inflation has been above the Fed's 2% goal since 2021. The Fed's targeted inflation gauge rose 3.6% in June, and July's reading is due Aug. 26.
The Fed's own projections, delivered in September, anticipated one rate this year. So the market is betting against the central bank's forecast, and the tension could come to a head soon.
The bottom line: A strategist at Aegon Asset Management says the inflation data cooled the rate-tightening debate, and current valuations support fixed income. He puts it simply: "On the data currently in front of us, talk of rate hikes looks misplaced."
A strategist at Natixis says further rallies will get harder, and the Fed chair's Jackson Hole speech could be a moment for hawkish communication. His team is staying cautious into late August, preferring intermediate maturities.
An analyst at Bloomberg warns that if the no-hike bet is wrong and mild disinflation reverses, markets could move toward a 50-basis-point hike in December.
For your portfolio, the story is about the tug-of-war between what the market expects and what the Fed might do. Bond prices have already risen on the hope of tame inflation.
If that hope fades, yields go up and bond prices fall. If it holds, the rally has room - but the Natixis strategist's caution suggests the easy gains are behind us.
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