Treasury yields slip after PCE data shows core inflation slowing in August

What’s happening

• The yield on the 2-year Treasury
  BX:TMUBMUSD02Y
  was 5.025%, down 4.6 basis points from 5.071% on Thursday. Yields move in the opposite direction to prices.

• The yield on the 10-year Treasury
  BX:TMUBMUSD10Y
  was 4.524%, down 7.2 basis points from 4.596% Thursday afternoon.

• The yield on the 30-year Treasury
  BX:TMUBMUSD30Y
  was 4.664%, down 6.4 basis points from 4.728% late Thursday.

What’s driving markets

Data released on Friday showed that inflation, based on the Fed’s favorite measure, the PCE price index, sped up by a sharp 0.4% in August — the biggest increase in seven months — due to higher gas prices. The increase over the past year climbed to 3.5% from 3.4% previously.

However, after excluding volatile food and energy costs, the narrower core rate that policy makers care most about rose a soft 0.1% for the month and decelerated to 3.9% from 4.3% over the past year. The year-over-year increase for core prices was the slowest 12-month pace in almost two years.

The inflation report didn’t meaningfully move the needle on Fed rate-hike expectations by year-end. Fed funds futures traders now see an 86.7% chance of no action in November, which would keep the Fed’s main interest-rate target at between 5.25%-5.5%, according to the CME FedWatch Tool. The chance of no hike in December was seen at 68.8%.

In other data, the nation’s trade deficit in goods dropped 7.3% in August to $84.3 billion versus $90.9 billion in the prior month.

What analysts are saying

“Friday’s PCE on a core basis, which removes food and energy prices, suggests that inflation is continuing to decelerate, meaning the Fed’s aggressive campaign is working. The challenge is that core PCE remains almost double the Fed’s 2% target, prompting the Fed to keep the possibility of another rate hike in play,” said Carol Schleif, chief investment officer of BMO Family Office, based in Minneapolis.

“Our base case is for higher market volatility through year-end as businesses and consumers continue to adjust [to] a higher-for-longer interest rate regime, which could dampen consumer demand heading into the all-important holiday shopping season,” Schleif wrote in an email. “A government shutdown could complicate the Fed’s ability to be data dependent which ironically could cause them to err on the side of holding steady, instead of increasing rates, until they get clearer data sets because economic data would not be tabulated during a government shutdown.”