Treasury Market’s Inflation Outlook Tumbles

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Summary

The Treasury market continues to downgrade US inflation expectations, which suggests that the case is strengthening for a rate cut by the Federal Reserve.
It appears that US economic growth is stabilizing at a moderate pace for the upcoming second-quarter GDP report.

Fed Funds futures, however, are still pricing high odds that the central bank will leave its current target range – 2.25-to-2.50% – unchanged in the June 19 policy statement.

The Treasury market continues to downgrade US inflation expectations, which suggests that the case is strengthening for a rate cut by the Federal Reserve.

The widely followed spread for nominal and inflation-indexed 5-year Notes fell to 1.53% yesterday (June 12), based on daily data published by Treasury.gov. That’s the lowest implied inflation rate for this maturity since January 3. It’s also a forecast that’s well below the Fed’s 2.0% inflation target and the core rate of consumer inflation, which rose at an annual 2.0% pace in May.

Although the inflation outlook is subdued and appears to be edging lower, some analysts advise that macro conditions still remain neutral and so there’s room for debate on whether a rate cut is required. “Inflation at the current run rate neither prevents nor forces action on rates,” observes AllianceBernstein’s senior US economist Eric Winograd. “It is low enough to allow for rate cuts but not so low as to require them.”

Note, too, that it appears that US economic growth is stabilizing at a moderate pace for the upcoming second-quarter GDP report.

Yet the hard data on consumer inflation is showing signs of trending lower, albeit gradually. The core pace of the Consumer Price Index (CPI) eased to a 2.0% year-over-year increase in May, the softest gain in over a year and modestly below the previous peak: last July’s 2.3%.

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