TREASURIES-Yields pop then drop as producer prices rise more than expected

BY Reuters | ECONOMIC | 05/14/24 09:57 AM EDT

By Karen Brettell

May 14 (Reuters) - Benchmark 10-year Treasury yields briefly hit an 11-day high on Tuesday after data showed that producer prices rose more than expected in April.

They then retraced ahead of a highly anticipated consumer price inflation report due on Wednesday that analysts say is likely to drive near-term Federal Reserve policy.

Producer prices showed strong gains in the costs of services and goods, indicating that inflation remained elevated early in the second quarter. The producer price index (PPI) for final demand rose 0.5% last month after falling by a downwardly revised 0.1% in March.

Guy LeBas, chief fixed income strategist at Janney Montgomery Scott in Philadelphia, said that the producer price inflation report doesn't mean that Wednesday's consumer price index (CPI) will be higher than anticipated, noting that "historically surprises in the PPI are uncorrelated with surprises in the CPI."

It also follows a cool reading in March, which when added together leaves the index close to its recent trends. "It looks like we've got some month to month chop rather than anything meaningful," LeBas said.

Benchmark 10-year note yields were last down 2 basis points on the day at 4.463%, after reaching 4.534% in the aftermath of the data, the highest since May 3.

Two-year yields fell 3 basis points to 4.832%, after getting as high as 4.899%, the highest since May 2.

The inversion in the yield curve between two-year and 10-year notes narrowed by one basis point on the day to minus 37 basis points.

Higher than anticipated consumer prices in the first quarter of the year raised concerns that the Fed will be unable to cut rates this year unless there is a significant uptick in the unemployment rate.

Weaker than expected jobs growth in April led investors to reset bets for two 25 basis point cuts this year, but the trajectory of inflation will be key to whether that occurs. Traders are now pricing in 44 basis points of cuts this year, down from around 46 basis points on Monday.

Economics polled by Reuters expect the closely watched core CPI to rise by 0.3% in the month, down from 0.4% in March, for an annual gain of 3.6%, down from 3.8%.

A higher-than-expected number will likely drive yields higher, but a softer report could also spark a large bond market rally, especially in light of market positioning.

"The markets are a little primed for a higher release, that seems to be what the hedges are all betting against," said LeBas.

The next CPI report for May will be on June 12, the second day of the Fed's two-day meeting, when policymakers are due to update their economic and interest rate projections. (Reporting by Karen Brettell; Editing by Franklin Paul)

In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible.

Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

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