US Treasury yields dipped immediately following the release of the Consumer Price Index (CPI) on Thursday, July 11.
This drop had a significant impact on financial markets: the decrease in inflationary pressures fueled a growing confidence in a potential easing of monetary policy by the Federal Reserve, which could come as soon as the September FOMC meeting.
While this pushed down yields on US Treasuries, it boosted the appreciation of the country’s bonds.
What could happen next?
According to CME data, in the options markets, the Treasury options’ CVOL (volatility index) has substantially decreased.
This indicates that investors feel more secure holding bonds in their portfolios than before and that confidence in a stabilization of monetary policy is on the rise.
This sentiment is shared in the currency market: with the drop in yields, global currencies have appreciated against the dollar, with the Dollar Index (DXY) now seemingly on a downward trend.
It is no coincidence that the CME’s FedWatch Tool estimates an 80% probability of a 25 basis point cut at the September meeting.
Looking at an ETF tracking US Treasuries, such as the iShares 20+ Year Treasury Bond ETF (TLT), which follows its benchmark, the ICE US Treasury 20+ Year index, provides a clear graphical representation of recent events.
The data shows a significant price increase in the ETF, reflecting the decline in yields following the release of inflation data, which showed a decrease compared to past readings from the Bureau of Labor Statistics (BLS).
However, the crucial question remains: are we sure that Treasury prices will continue to rise so significantly? While expectations of an interest rate cut and decreasing inflation are positive factors for Treasury prices, there are other variables to consider.
One hotly debated issue is the inversion of the yield curve: despite the low current likelihood of a recession, the yield curve remains inverted.
This could make long-term bonds, with higher duration, less sensitive to changes in monetary policy.
The situation could be different for the short-term curve segment, showing a yield that may not be entirely indicative of the risk associated with short-term bonds.
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