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Subdued Inflation Data Ease Market-Volatility Worries

U.S. economy shows few signs of overheating despite tight labor markets

By Daniel Kruger

The Wall Street Journal

U.S. government-bond prices bounced Tuesday after closely watched data on consumer prices signaled inflation remains muted (faible), easing concerns among investors that rising prices could spark a fresh wave of volatility in financial markets.

The yield on the benchmark Treasury 10-year note, which serves as a reference rate for corporate debt, mortgages and consumer loans, shot up by roughly half a percentage point in about five weeks earlier this year as investors piled into bets that prices were primed to rise. Many anticipated that a $1.5 trillion tax-cut package and a budget agreement expected increase spending by roughly $300 billion would help lift prices and could cause the Federal Reserve to accelerate the pace of interest rate increases.

Tuesday’s data were the most-recent sign that those expectations, which helped spur swings in financial markets earlier this year, may have been premature.

The Labor Department said the consumer-price index, which measures what Americans pay for everything from washing machines to hotel stays, rose 2.2% in the 12 months to February, below the 2.3% estimated by economists surveyed by The Wall Street Journal. Core prices, which exclude energy and food, rose 1.8% for a third straight month, also below economists’ expectations, suggesting that inflationary pressures are still soft.

Bonds strengthened following the report, with the yield on the benchmark 10-year U.S. Treasury note dropping to 2.848% from 2.870% Monday and notching its lowest close since March 1. Yields fall as bond prices rise. Soft inflation is good for the value of bonds because it helps preserve the purchasing power of their fixed payments.

“We’ve been expecting inflation pressures for some time,” said Tom Stringfellow, chief investment officer at Frost Investment Advisors. “They’ve not lived up to expectations.”

The price data came after last week’s jobs report showed tepid wage gains, suggesting that while the economy is continuing to grow, tight labor markets aren’t generating signs of overheating.

Throughout the year, investors and analysts have been asking whether signs of a pickup in inflation could push the Fed to raise short-term interest rates four times this year, rather than the three it has penciled in. Minutes of the central bank’s January meeting, which suggested policy makers were becoming increasingly hawkish, helped send the yield on the 10-year note to a multiyear closing high of 2.943% toward the end of February.

Created with Highcharts 6.0.4Market-implied probability for four interest-rate increases in 2018Source: CME Group

But by Tuesday afternoon, federal-funds futures, used by traders to place bets on the course of interest rates, showed a 32% chance of the Fed raising short-term interest rates four times by year-end, according to CME Group, down from 35% Monday but up from 17% one month ago.

And the 10-year break-even rate, a gauge that measures the bond market’s expectations for inflation over the next decade, edged lower: The difference in yields between Treasurys and the equivalent maturity of Treasury inflation-protected securities fell to 2.1081% on Tuesday from 2.1177% Monday, according to Thomson Reuters.

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