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TREASURY WRAP: T-NOTE FUTURES (Z6) SETTLE 8 TICKS LOWER AT 106-03+

The session fits the classic late-cycle pattern in which a firm core inflation print lands days before an FOMC decision: the front end reprices the near-term path almost mechanically while the long end fades, producing a bear flattening.

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TREASURY WRAP: T-NOTE FUTURES (Z6) SETTLE 8 TICKS LOWER AT 106-03+

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Yield curve flattens after hot CPI bolsters Fed rate hike bets next week. At settlement, 2-year +4.8bps at 4.634%, 3-year +4.1bps at 4.722%, 5-year +2.6bps at 4.786%, 7-year +2.1bps at 4.873%, 10-year +1.4bps at 4.975%, 20-year unchanged at 5.393%, 30-year -0.7bps at 5.359%,

THE DAY: The Treasury yield curve flattened on Friday, with front-end yields rising while long-end yields were flat following the hotter-than-expected US inflation report. August core CPI rose 0.3% M/M, above the 0.2% forecast, while the remainder of the report was broadly in line with expectations. The hotter-than-expected core print saw money markets increase the probability of a 25bp hike at next week's FOMC to around 86%.

The hotter-than-expected inflation data, coupled with Fed Chair Warsh's hawkish commentary at Jackson Hole and last week's robust August labour market report, has made a rate hike next week increasingly likely. Oxford Economics, however, does not view a hike as a slam dunk, arguing that the Fed's preferred PCE inflation measure is likely to prove more benign.

With markets now heavily positioned for a September hike, the long end of the curve moved in the opposite direction, with yields declining despite the hotter CPI report. The move may partly reflect concerns that tighter monetary policy will ultimately weigh on growth and inflation further out, contributing to the flattening of the curve. However, long-end yields had also risen substantially heading into the report, suggesting some of Friday's rally may have reflected position squaring following the recent sell-off.

Elsewhere, there was little reaction to the preliminary September UoM survey, which saw a notable downside miss in consumer sentiment, while both 1-year and long-run inflation expectations increased.

The next major test for the Treasury market will be next week's FOMC rate decision, with a 25bp hike now largely expected. As such, attention will also be on the updated SEP and dot plot, alongside Chair Warsh's commentary, for guidance on the policy outlook beyond September. Elsewhere, rate decisions from the BoE (expected hold) and BoJ (expected 25bp hike) will be in focus, alongside US retail sales. Treasury supply will also return with the September 20-year bond and 10-year TIPS auctions.

SUPPLY

Notes

  • US to sell USD 13bln of 20yr bonds on September 15th; to settle on Sept. 18th; to sell USD 19bln of 10yr TIPS on Sept. 17th; to settle on Sept. 30th

Bills

  • US to sell USD 92bln of 13-wk bills and USD 79bln of 26-wk bills on Sept. 14th, to sell USD 75bln of 6-wk bills on Sept. 15th.

STIRS / OPERATIONS

  • Fed Hike Pricing via CME FedWatch: Sept 21.6bps (prev. 18.1bps), Dec 48.5bps (prev. 44.3bps)
  • EFFR at 3.63% (prev. 3.63%), volumes at USD 108bln (prev. USD 110bln) on September 10th
  • SOFR at 3.62% (prev. 3.64%), volumes at USD 2.921tln (prev. USD 2.859tln) on September 10th
  • NY Fed RRP op demand at 5.25bln (prev. 4.74bln) across 3 counterparties (prev. 4) on September 11th
Context

The mechanism here is the split between policy expectations, which sit at the two-year point and drove the bulk of the move, and the term premium and growth assumptions embedded in the long end, which rallied despite the hot data. That divergence typically reflects either conviction that tighter policy compresses growth and inflation further out, or, as flagged here, simple position squaring after a sustained long-end selloff, and the two are usually distinguishable only by whether the flattening persists into and through the meeting. With the hike now largely priced, the event risk has shifted from the rate decision itself to the signal content around it: the SEP, the dot distribution, and the tone of the press conference, which is where surprises of this kind have historically repriced the curve when the headline move is consensus. The 20-year and 10-year TIPS supply arriving into the meeting week adds a concession dynamic that has, in comparable sequences, steepened the curve into the auctions only to be subsumed by the policy outcome. The parallel central bank decisions abroad matter mainly through the cross-market channel: a surprise from the BoJ in particular has tended to transmit into the Treasury long end via Japanese investor flows rather than the front end. Worth observing is whether two-year yields hold the post-CPI levels into the decision or leak back, since fading a fully priced hike ahead of the meeting has often been the tell that positioning, not conviction, drove the move.

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