US bonds fall as markets weight inflation, Middle East risks

U.S. Treasuries retreated on Monday, in line with weakness across European bond markets, as investors braced for key inflation readings this week that could point to persistent price pressures, while keeping a close eye on continued geopolitical Middle East tension as oil prices rose.

The move reversed part of Friday's rally, which followed weaker-than-expected U.S. nonfarm payrolls data, as ‌traders re-established short positions ⁠and pared ⁠long exposure.

In late morning trading, the benchmark 10-year yield rose 3.6 basis points (bps) to 4.694%. U.S. 30-year bond yields were up 3.0 bps at 5.240%. ​Rising yields mean bond prices are lower.


On the shorter end of the curve, the yield on 2-year notes , which are sensitive to market expectations for Federal Reserve interest rate moves, advanced 3.3 bps to 4.237%.

"Markets are definitely waiting for CPI and PPI," said Tom di Galoma, managing director for global rates trading at Mischler Financial, noting that the inflation numbers were far from disinflationary, and could come in above market forecasts.

The consumer price index (CPI) is ⁠forecast to ‌rise 0.1% in July from a 0.4% fall in June, while the year-over-year figure is expected ​at 3.4% from ​3.5% the previous month, according to a Reuters poll. The core CPI forecast was for ⁠a 0.1% rise while the year-on-year number was seen at 2.5%.

The headline U.S. ​producer price index is seen rising 0.2% in July after a 0.3% decline. Year-over-year, ​PPI is expected to rise 4.9% after advancing 5.5% in June.

US RATE FUTURES; IRAN

"In the event that core-CPI comes in line with...consensus, the FOMC (Federal Open Market Committee) would be compelled to keep rates unchanged if it was only the July data driving the decision," wrote Ian Lyngen, head of U.S. rates strategy, at BMO in a research note.

U.S. rate futures priced in a 48% chance the Federal Reservs will hike rates next month, down from 67% a week ago, according to ‌the CME's FedWatch.

The Iran war was also a factor driving the selloff, Mischler's di Galoma said. Iran has tied the reopening of the Hormuz Strait to the United States meeting certain conditions. That pushed U.S. crude futures up 3.4% at $80.84 per barrel.

Aside from ⁠the war, this week's Treasury supply also weighed on prices, with the auction of $58 billion in 3-year notes on Tuesday, $42 billion in 10-year debt on Wednesday and $25 billion in 30-year bonds on Thursday.

The U.S. Treasury also sold $92 billion in 13-week ​bills and $79 billion in 26-week bills on Monday.

The auctions create a classic 'concession-building dynamic: dealers and real money push yields higher to attract end-investor demand.

In other parts of the bond market, the yield curve steepened on Monday ahead of the CPI and PPI numbers, with the gap between 2-year and 10-year yields widening to 46.2 bps, compared with 44.8 bps late on Friday.

The curve showed a bear steepening scenario, in which long term interest rates are rising faster than shorter-dated ones, suggesting a pick up in inflation expectations.