Yields fall, views on Fed easing intact after inflation, labor data

The yield on the 10-year Treasury note dipped to a five-month low on Thursday after reports on consumer prices and jobless claims reinforced the view that economic conditions are right for the Federal Reserve to ease next week for the first time in nine months.

A decent, if unspectacular, auction of 30-year bonds underscored solid demand for Treasuries seen through the week.

The benchmark 10-year yield briefly fell below 4% to its lowest since the April tariff crisis after the Labor Department said its August Consumer Price Index rose 0.4%. That followed July's 0.2% rise and was just above the 0.3% increase expected. Year-on-year, the CPI rose 2.9% as expected, a bit hotter than July's 2.7% rise.

The market looked beyond the warmer-than-expected number, however, confident that inflation would not be severe enough to keep the Fed on hold after next week's meeting, especially after a fall in producer prices on Wednesday.

"Thankfully it wasn't too far off of consensus. So I think in many ways the market's viewing it as a bit of a relief that it wasn't worse," said Nate Thooft, chief investment officer for equity and multi-asset solutions at Manulife Investment Management.

"Let's be honest though, if we would have gotten this type of report even a handful of months ago, the markets would have had a much more negative reaction."

It was a report on the other side of the Fed's dual mandate, which showed a weakening labor market, that caught the market's attention and reinforced expectations of at least a 25 basis point cut. The jobless claims release showed 263,000 people filed for unemployment insurance last week, much more than expected and more than the revised 236,000 last week.

"The slightly elevated CPI, and core CPI being in line with expectations, reinforces the notion that the Fed is going to cut rates next week," said Oliver Pursche, senior vice president, advisor, at Wealthspire Advisors in Westport, Connecticut.

"The higher unemployment filings suggest there's a possibility it could be 50 basis points as opposed to 25 ... although I think that's still only a remote possibility. But it certainly seems like 'bad news is good news' is back," Pursche said.

Rate futures pricing now reflects bets on three straight quarter-point Fed rate cuts, one at each meeting left this year, starting with the meeting next week.

The yield on the benchmark U.S. 10-year Treasury note touched 3.994% (US10YT=TWEB) and was 1.7 basis points lower as trading wrapped up, at 4.015%.

The two-year (US2YT=TWEB) U.S. Treasury yield, which typically moves in step with interest rate expectations for the Fed, fell 0.2 basis points to 3.531%.

A closely watched part of the U.S. Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes (US2US10=TWEB), seen as an indicator of economic expectations, flattened to positive 48.2 basis points.

The yield on the 30-year bond (US30YT=TWEB) ended 2.3 basis points lower at 4.654%. That was still above where it was trading after the $22 billion T-bond sale, which Lou Brien, strategist with DRW Trading in Chicago, said was in line with market pricing going into the bidding deadline.

"Once again there was plenty of demand for this paper and the Primary dealers were not needed to pick up the slack," he wrote in a note after the auction.

Given fiscal worries and a focus on longer maturities globally, the T-bond sale was arguably the most watched but least sensational of three this week, following very strong demand for three- and 10-year notes.

The breakeven rate on five-year U.S. Treasury Inflation-Protected Securities (TIPS) (US5YTIP=TWEB) was last little changed on the day at 2.439%.

The 10-year TIPS breakeven rate (US10YTIP=TWEB) was last at 2.364%, indicating the market sees inflation averaging about 2.4% a year, just above the Fed's 2% target, for the next decade.