- Oil prices have plummeted to a four-month low, easing inflation concerns and prompting a broad decline in U.S. Treasury yields, with the 2-year Treasury yield hitting a near one-week low of 4.137%.
- Federal funds futures traders maintain a high 68% probability of a Fed rate hike in September, with market focus shifting entirely to the upcoming May core PCE price index release.
- The U.S. Treasury's auction of $70 billion in 5-year bonds faced weak demand, with the winning yield recorded at 4.20%, the highest since January 2025, triggering a tail effect.
Energy Price Decline Triggers Bond Market Reassessment
As tankers detained in the Strait of Hormuz gradually depart, the dissipation of supply disruption premiums led to a sharp 3% drop in Brent crude prices in a single day, directly triggering a short-covering in the U.S. bond market. As a key indicator of medium-term inflation expectations, the 5-year breakeven inflation rate has significantly fallen from 2.74% in May to 2.20%. Since energy costs are a crucial factor in driving core inflation, the retreat in oil prices has temporarily alleviated bond market fears of cost-push inflation, causing yields across all maturities to decline from their highs.
Rate Hike Pricing Ahead of Core PCE
Despite the softening of oil prices, the absolute levels of long and short-term Treasury yields still reflect the pressure of monetary policy tightening. The market is currently awaiting the release of the U.S. May personal consumption expenditures inflation report on Thursday. Institutions generally predict that the core PCE price index will rise by 0.3% month-on-month in May, with a year-on-year increase of 3.4%, while the overall PCE year-on-year increase is expected to reach 4.1%. If the core inflation data does not decelerate as expected month-on-month, expectations for the Fed to resume rate hikes may further strengthen.
Flattening Yield Curve and Term Premium
Affected by the unclear rate hike path, the U.S. Treasury yield curve continues to exhibit a flattening structure, with the spread between 2-year and 10-year Treasury bonds narrowing further to 25.9 basis points. The benchmark 10-year U.S. Treasury yield fell to 4.398%, the lowest level since May 11; the 30-year Treasury yield also declined to 4.849%. Market analysis indicates that as the index of monetary policy uncertainty rises, investors may demand higher compensation for long-term risks, posing an upward risk to term premiums in the short term.
Shift in Forward Guidance and Supply-Side Pressure
The Federal Reserve kept the benchmark rate unchanged at its June policy meeting, but new Chair Walsh did not submit personal forecasts in the dot plot, sparking speculation that he may gradually abandon forward guidance. If the dot plot system is canceled or modified in the future, the market may experience increased volatility due to the loss of policy anchoring. Meanwhile, the U.S. Treasury's auction of $70 billion in 5-year bonds on Wednesday had a winning yield of 4.20%, nearly 1 basis point higher than the pre-issuance trading yield, indicating marginal pressure on primary market absorption of mid-term bonds amid a weekly issuance wave of $183 billion.
