BOND REPORT: Treasury Yields Mostly Fall After Worse-than-expected Inflation Report

Consumer price inflation for July at 0.1%, slightly below the consensus forecast of 0.2%

Treasury prices rose Friday, dragging yields mostly lower, after consumer price inflation missed expectations, reflecting the recent spate of anemic economic data that has cut into expectations that the Federal Reserve will push for an aggressive pace of monetary tightening this year.

The 10-year Treasury yield slipped 2 basis points to 2.190% from 2.211% in the previous session, extending a three-day decline. Bond prices move inversely to yields.

The 2-year Treasury yield fell more than 5 basis points to 1.286%, versus 1.335% on Thursday. On the other hand, the yield for the 30-year Treasury bond, known as the long bond, added close to 1 basis point to 2.793%, from 2.788% in the prior session.

Short-dated yields, sensitive to the swings and sways of Fed monetary policy, plummeted after consumer price inflation grew 0.1% in July, falling below the 0.2% gain forecast by economists surveyed by MarketWatch.

Core CPI, which excludes volatile food and energy costs and of particular focus at the central bank, also increased 0.1%. Consumer prices on a core basis stayed at an annual rate of 1.7%, close to the Fed's 2% long-term inflation target.

See: U.S. consumer inflation remains soft in July, CPI shows (http://www.marketwatch.com/story/us-consumer-inflation-remains-soft-in-july-cpi-shows-2017-08-11)

But some economists said market participants had focused too much on the headline figures and ignored the more significant trend within the mixed report.

"We're seeing some sort of stabilization [in core inflation] this year," said David Page, senior economist for AXA Investment Managers, pointing out some component gauges of consumer price data were susceptible to sharp movements in commodity prices.

This could prove pivotal as senior Fed officials have shown concerns over the deterioration of core inflation from February to May, bearing out Fed Chairwoman Janet Yellen's prognostication that inflation was transitory.

One puzzling reaction to the data was a widening of the spread between the 2-year Treasury note and the 30-year bond, a measure of the so-called yield curve that would suggest bond investors' expectations for inflation had actually risen. But Page said this could be down to investor positioning and short-term tactical trades, rather than a substantial change in the assessment of the economic picture.

Moreover, the widening yield gap was mostly driven by the steep fall in the yield for the 2-year Treasury note, which reflected that expectations for a quarter-percent rate hike in December were rapidly diminishing. Traders ramped down their bets on higher interest rates for December, falling to 35.2% from 42.8% the day earlier, according to the Chicago Mercantile Exchange's FedWatch tool (http://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html/).

For all the hand-wringing over monetary tightening, senior Fed officials would likely sit on their decision for a rate increase this year to focus on preparing market participants for a winding down of the balance sheet in the September policy meeting.

To signal a further rate increase in the face of lackluster data could stoke fears of a policy misstep, said John Bredemus, fixed-income strategist for Allianz Investment Management.

Also read: Fed won't like soft July CPI data but has four months to get over it (http://www.marketwatch.com/story/fed-wont-like-soft-july-cpi-data-but-has-four-months-to-get-over-it-2017-08-11)

The morning data release also had a pronounced impact on the dollar. The dollar index , a gauge of the greenback's performance against a group of major currencies, fell around 0.2% to 93.2. The weakening currency could, however, help inflation stage a rebound toward the tail-end of the year as tepid import prices have weighed on inflation measures (http://www.marketwatch.com/story/falling-import-prices-show-that-barely-any-inflation-is-coming-into-the-us-from-abroad-2017-07-18), said Page.

Traders also eyed a speech by Minneapolis Fed President Neel Kashkari, a voting member, with several senior Fed officials having already spoken this week (http://www.marketwatch.com/story/fed-risks-being-too-aggressive-on-rate-hikes-bullard-says-2017-08-09) on the inflation outlook. Kashkari said the monetary hawks -- those in favor of normalizing interest rates at a quicker pace -- were telling a "ghost story" about higher wage inflation, and (http://www.marketwatch.com/story/feds-kashkari-says-central-banks-hawks-are-spooked-by-ghost-story-of-higher-wages-2017-08-11)that there was no evidence it would "take off."

Elsewhere, inflation measures from eurozone members dragged bond yields for the region lower. Consumer prices in Spain slipped 0.7%, while falling in France by 0.35%. In addition, German 10-year government bonds, or bunds, fell to 0.391%, even as the country's inflation rate posted a 0.4% increase in July.

(END) Dow Jones Newswires

August 11, 2017 13:55 ET (17:55 GMT)