- As investors anticipate a possible ceasefire agreement between the United States and Iran, U.S. Treasury yields fell for the fourth consecutive trading day. The benchmark 10-year U.S. Treasury yield (US10YT=TWEB) dropped 1.6 basis points to 4.439% on Friday, with a cumulative decline of 12.5 basis points this week, marking the largest weekly drop since early February.
- Although the easing of tensions in the Middle East led to a decline in oil prices, providing a breather for the bond market, the U.S. Commerce Department's recently released Personal Consumption Expenditures (PCE) price index rose to a three-year high. Coupled with a strong Chicago Business Barometer, this has fueled ongoing market concerns about the risk of economic stagflation.
- Federal Reserve (Fed) Vice Chair for Supervision Michelle Bowman stated that it is still too early to assess the long-term impact of the Middle East conflict on the economy. If geopolitical energy shocks persist, the Fed may need to promptly adjust its current monetary policy stance.
Geopolitical Agreement Expectations Ease Inflation Premium
Reports of progress in ceasefire agreement negotiations between the U.S. and Iran have led to a temporary retreat in geopolitical risk premiums. The upward pressure on oil prices and inflation expectations has eased against the backdrop of last month's fragile ceasefire, directly contributing to the general decline in Treasury yields. DRW Trading market strategist Lou Brien noted that the drop in oil prices has provided a valuable respite for the bond market, but a potential agreement alone may not completely eliminate the threat of high oil prices. If subsequent geopolitical negotiations falter, oil prices could once again pressure the bond market.
Stagflation Signals and Strong Economic Data Intertwine
While yields are declining, the complex performance of macroeconomic data keeps the bond market outlook uncertain. Data previously released by the U.S. Commerce Department showed that the Fed's preferred inflation measure, the core PCE price index, rose to its highest level in three years last month. Several Wall Street analysts have indicated that this inflation data, along with a series of recently released macroeconomic indicators, has jointly issued a warning signal of economic stagflation. However, subsequent U.S. trade balance data slightly exceeded expectations, and the MNI Chicago Business Barometer, which measures business activity in the Chicago area, performed strongly, significantly surpassing market expectations and reaching its highest level in over four years, indicating that local economic resilience remains robust.
Short-End Yield Curve Pressure and Long-End Trends
In terms of specific maturities, the 2-year U.S. Treasury yield (US2YT=TWEB) fell 2.5 basis points to 4%, with an expected cumulative weekly decline of 11.3 basis points. The 30-year U.S. Treasury yield (US30YT=TWEB) slightly decreased by 0.2 basis points to 4.983%, with a weekly cumulative decline of 8.9 basis points, marking the largest weekly drop since late February. It is noteworthy that despite the temporary pullback this week, due to the stickiness of inflation expectations, the 2-year, 10-year, and 30-year Treasury yields have still risen by 12.9 basis points, 5.9 basis points, and slightly, respectively, over the entire month, recording a third consecutive monthly increase. Currently, the yield spread between the 2-year and 10-year U.S. Treasuries (US2US10=TWEB) stands at a positive 43.7 basis points.
Monetary Policy Path Depends on External Variables
The Fed's internal considerations for the future policy path still depend on the evolution of external variables. Bowman's remarks suggest that if core inflation rebounds due to energy price fluctuations, the market's pricing of the Fed's rate cut timing may face reevaluation. From the pricing of the Treasury Inflation-Protected Securities (TIPS) market, the 5-year TIPS breakeven yield fell from 2.559% on May 28 to 2.527%, while the 10-year TIPS breakeven yield stands at 2.39%, indicating that the market currently expects the average annual inflation rate over the next ten years to remain around 2.4%. If future supply-side shocks in commodities persist, the Fed's restrictive interest rate policy may last longer than the market anticipates.
