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Bond Report: Treasury yield curve inverts by most in almost 22 years after June CPI report comes in hotter than expected

Short dated Treasury debt yields soared on Wednesday, led by rates on T-bills and the 2-year note, after a hotter-than-expected inflation reading for June gave credence to a full percentage point interest rate hike by the Federal Reserve at its meeting in two weeks.

The rise in the 2-year yield left its spread to the 10-year maturity at minus 23.8 basis points as of 3 p.m. Eastern time, the most inverted level since Sept. 26, 2000, according to Dow Jones Market Data.

What’s happening

The yield on the 2-year Treasury

rose 9.9 basis points to 3.142% from 3.043% as of late Tuesday. The daily rise was the largest since July 6, based on 3 p.m. levels, according to Dow Jones Market Data.

The yield on the 10-year Treasury

declined 5.5 basis points to 2.904% after factoring in reopening levels.

The yield on the 30-year Treasury

fell 6.9 basis points to 3.067% from 3.136% on Tuesday.

The 10- and 30-year yields are both lower for the third consecutive trading session.

What’s driving markets

Data released on Wednesday showed that the rate of U.S. inflation surged to an almost 41-year peak of 9.1% last month, offering little hope of help soon for Americans suffering from a high cost of living. Economists had expected year-over-year inflation to hit 8.8% in June, up from 8.6% the month before.

Lower gasoline prices since mid-June offer some hope that July’s data won’t look nearly so bad, though inflation-derivatives traders foresee three more 8%-plus CPI readings for July, August and September.

June’s hotter-than-expected reading raised the chances that the Federal Reserve may become even more aggressive in hiking interest rates. After Wednesday’s CPI data was published, fed funds futures pointed to an 82% likelihood of a full percentage point Fed rate hike in two weeks, up from 7.6% on Tuesday.

Fed funds futures traders also see an 18% chance of a 75 basis point hike at the Fed’s July 26-27 meeting, according to the CME FedWatch Tool.

The deeply inverted 2-year/10-year spread signaled the potential for a looming economic downturn.

10-year Treasury yield minus 2-year Treasury yield

Tradingview chart, FRED data.

The Fed’s Beige Book report, released on Wednesday, noted that substantial price increases were reported across all districts.

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What investors are saying

“We do see early signs of inflation decelerating and think that trend is something we’re going to see as the economy continues to weaken in the near future,” said Mace McCain, chief investment officer of Frost Investment Advisors in San Antonio, Texas, which manages $4.4 billion in assets. “Unfortunately, a lot of contributors such as home prices will take a while to feed through for this headline number to begin looking like inflation has peaked.”

“We’re convinced that we’re in the peaking process here, led by housing and consumer goods,” McCain said. “But the question is once inflation decelerates, where do we settle? We’re in the camp that sees some persistent pressures that will keep inflation above the Fed’s comfort zone, at 4% to 5%, by year-end.”

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