The two-year government bond yield, which tracks expectations for Fed policy more closely than any other, dipped below 4.10% on Friday. That was its lowest point since June 30.
It later bounced back to around 4.17% as a selloff in UK government debt spilled into global markets. Even so, it finished the week about three basis points lower, and a basis point is one hundredth of a percentage point.
Investors are losing faith in the case for more rate hikes.
Retail sales unexpectedly fell in July, after a soft jobs report released Aug. 7 and mild inflation readings. Together, those reports suggest the economy is cooling, which makes the Fed less likely to raise rates.
The 10-year government bond yield finished the week up five basis points, and the 30-year gained six. That split widened the gap between short-term and long-term yields, a measure known as the yield curve.
The curve is now the steepest it has been since May. The 10-year yield trades at a premium of over 50 basis points compared to the two-year, while the 30-year sits about 90 basis points above the five-year.
Bryce Doty, who manages bond portfolios at Sit Investment Associates, says the split reflects a specific worry: putting off hikes could let inflation flare up again. "Weak numbers are creating a fear that the lack of rate increases will create a resurgence of inflation," he said.
The fear showed up in the auction market, too. Thursday's sale of new 30-year bonds produced the highest yield for that maturity since 2001, and Wednesday's 10-year note auction was the highest since 2007.
Investors wanted more compensation to lend money for decades, which is another sign the inflation fight is not over. Doty put it simply: "The curve-steepening trade is alive and well."
Traders have also dropped bets on more than one hike by mid-2027.
The reversal shows up clearly in the pricing for September. It has fallen to about nine basis points of tightening, down from close to 19 basis points on July 31.
The shift has been building for a while. The July jobs report, released Aug. 7, came in below expectations, and this week's mild consumer and producer price data added to the case for holding steady.
The weak retail sales numbers pushed expectations the rest of the way. Roughly two months ago, the picture looked very different.
The Fed's revised quarterly projections revealed increasing backing for a rate hike this year, a stance that developed after a jump in oil prices worsened inflation. Inflation has stayed above the Fed's 2% target since 2021, and at last month's policy meeting, three policymakers wanted to raise rates.
Doty thinks the hesitation is justified. He said the US economy is in a soft patch that supports delaying hikes. He also said this year's inflation is supply-driven rather than demand-driven, so the Fed is right to wait.
The bond market is now betting that the Fed is done raising rates, at least for a while. But it is not betting that inflation is done. That matters for your portfolio because government bond yields are the foundation for borrowing costs across the economy. When short yields fall and long yields rise, it is the market's way of saying the economy is slowing while price pressures persist.
For investors, the takeaway is not an all-clear signal. The bond market sees a soft patch ahead, but it is not ready to declare victory over inflation.