- U.S. Treasury yields edged higher on Wednesday, primarily driven by the renewed escalation of U.S.-Iran geopolitical tensions. The potential inflationary pressures from Middle Eastern geopolitical risks offset the downward relief space brought by the previous slowdown in the core Consumer Price Index increase.
- In May, the U.S. core Consumer Price Index rose by 2.9 percentage points year-on-year, below market expectations. However, the overall Consumer Price Index increased to 4.2 percentage points year-on-year, the highest level since April 2023, indicating that rising energy costs are being transmitted to the service sector.
- Interest rate futures market pricing shows that the probability of a Federal Reserve rate hike before December remains at 65 percentage points. Meanwhile, the Treasury's auction of $39 billion in 10-year bonds saw strong demand, with the bid-to-cover ratio reaching its highest level since September last year.
Geopolitical Risks Drive Oil Prices, Raising Inflation Concerns
U.S. President Trump issued a warning to Iran, stating that it is taking too long to negotiate an agreement and must pay a price. After carrying out retaliatory attacks, Iran announced it would reassess its diplomatic engagement with the U.S. The recent incident of a U.S. military helicopter being shot down near the Strait of Hormuz marks a significant escalation in tensions since the ceasefire agreement in April. The ongoing geopolitical conflict continues to draw traders' close attention to crude oil price trends. The potential cost pressures from rising oil prices are pushing up Treasury yields, and if the geopolitical conflict becomes prolonged, commodity costs may continue to provide potential support for inflation.
Core Inflation Slows Amid Service Sector Price Pressures
In terms of macroeconomic data, Refinitiv data shows that the U.S. core Consumer Price Index (CPI) rose by 0.2 percentage points month-on-month in May and by 2.9 percentage points year-on-year, both below economists' general expectations. However, influenced by volatile food and energy prices, the overall CPI rose by 0.5 percentage points month-on-month, with a year-on-year growth rate of 4.2 percentage points. Matt Bush, a U.S. economist at Guggenheim Investments, noted that although the data indicates that the underlying impact of tariffs on prices continues to weaken and technology-related inflation has eased, service prices remain high, and rising energy costs are gradually being transmitted to services such as airfares. Additionally, although the slowdown in rental inflation is less than some analysts expected, it suggests there is still potential for further improvement in the coming months.
Yield Curve Trends and Monetary Policy Pricing Anchors
Amid the interplay of data and geopolitical factors, U.S. Treasury yields showed a slight divergence. The yield on the U.S. 2-year Treasury (US2YT:US), which typically moves in sync with Federal Reserve (Fed) rate expectations, remained stable, closing at 4.125 percentage points. The benchmark U.S. 10-year Treasury (US10Y:US) yield rose by 1.2 basis points to 4.540 percentage points, widening the yield spread between the 2-year and 10-year Treasuries to 41.4 basis points. Federal funds rate futures traders currently assess the probability of a Fed rate hike before December at 65 percentage points, showing little change from the previous trading day, indicating that macroeconomic data may not fully sway the Fed's current policy stance in the short term.
Strong Demand for 10-Year Treasury Auction Reaches Recent High
Despite facing dual uncertainties on the macroeconomic and political fronts, the U.S. Treasury's auction of $39 billion in 10-year bonds on Wednesday saw robust demand, providing phased support for the week's total of $119 billion in coupon-bearing bond auctions. The winning yield for this auction was 4.538 percentage points, slightly below pre-auction trading levels. Notably, the bid-to-cover ratio reached 2.57 times, the highest record since last September, reflecting that fixed-income assets remain highly attractive to institutional investors at current yield levels. If the subsequent 30-year Treasury auction also maintains steady demand, the pressure on the bond market's supply side may be further alleviated.
