Bessent holds steady on US Treasuries; how will Warsh set the tone for the market at the annual meet

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Gaozhan Weekly Rates Analysis | Cooling CPI vs. Surging Rate Hike Odds: Is July FOMC Pricing Polarized in the Waller Era?

Issue No. 202619

In our previous column, we unpacked the dynamics of strong oil and weak goldinterest rate hikethe pricing logic behind the expected reversal and cooling, clarifying that supply shocks have been priced by the market asterm premiuman expansion rather than an upward revision to the policy rate path.

Building on this, this issue will further exploreJune CPICooling down and JulyFOMC rate hikeExpected reverse repricingPricing paradox。

Last weekWithin,June CPIYear-over-year from4.2%dropped to3.5%、core CPI,Month-over-month flat, but FedWatch shows JulyFOMC rate hikeProbability from a week ago12.8%soared to33.7%, cumulative as of Septemberinterest rate hikeprobability of a 25-basis-point hike reaches57%, at leastinterest rate hikeprobability of a 50-basis-point hike reaches60%。

This article will systematically analyzeMechanism Breakdown、Curve Shape、Scenario AnalysisThree dimensions for systematic analysis of the core pricing logic in this issue.

▌FedWatch Data Quick View

CME FedWatch(as ofJuly 26) shows, withFOMC on July 29Meeting in 3 days; interest rates expected to remain unchanged3.50%-3.75%Probability is66.3%，interest rate hiketo3.75%-4.00%Probability is33.7%。

Compared to a week ago12.8%'sinterest rate hikeProbability surged20.9 percentage points; compared to a month ago29.9%rise3.8 percentage points. Cumulative for Septemberinterest rate hike25 basis points probability reaches57%, at least 50 basis points by Decemberinterest rate hikeprobability reaches60%。

interest rate hikeExpectations have shifted from the July meeting to September and December, with a clear repricing of the rate path.

▌ Paradox: Cooling CPI yet renewed rate hike expectations

Last week's June CPIdata came in below market expectations across the board: year-over-year dropped from May's4.2%dropped to3.5%，core CPI,month-over-month fell from0.2%to zero.

However, in JulyFOMC rate hikeProbability has increased rather than decreased, forming a classicpricing paradox。

The market has priced the cooling CPI as"transitory", while pricing the oil price shock and Walsh's silence as"persistent", reflectinginterest rate hikeExpectations have shifted away from single data points towardpolicy pathandinflationdual pricing of the path.

▌ Topic Breakdown: Waller Goes Silent

Federal Reserve Chair Kevin Warshsince taking office in May,Preliminary Guidancehas sharply reduced communication with markets,"going silent"。

This shift in communication styleis forcing institutions to reconstruct their frameworks for assessing monetary policy, pushing markets to rely on data and alternative information sources for pricing,interest rate hikewith expectations that sensitivity to any single data point will decline.

Morgan Stanleywarns that ifinflationfailed to retreat as expected,the Federal Reservehas insteadinterest rate hikeincreased the likelihood of a pivot.

▌ Fed Watch: Market Perspective

Kevin Warshof the «silent policy" andJune CPIcooling data are creating tension.

CITIC SecuritiesMaintain the view of holding steady throughout the year, butMorgan Stanleystrategists warn:the Fedis losing patience with readings above target,inflationand developments over the coming monthsinflationwill be critical; ifinflationthey do not ease as expected,the Fedcould pivot later this yearinterest rate hike。

The money market has priced in nearly two rate cuts by year-endinterest rate hikeProbability of holding steady in July65.3%, Septemberinterest rate hike25 basis points probability57%, at least 50 basis points by Decemberinterest rate hike50 basis points probability60%。

▌ Key Data & Events: June CPI and U.S. Treasury Auctions

June CPIyear-over-year3.5%(previous)4.2%)，core CPI,MoM0.0%(Previous value0.2%), significantly below market expectations.

The cooling of CPI was primarily driven by a pullback in energy costs,core goodsposting negative growth, andthe shelter componentslowing its pace of increase, jointly contributing to the decline.

However,CITIC Securitiesnoted that the pullback in the energy component is temporary, and a rebound in oil prices would quickly reverse theinflationtrajectory.

U.S. Treasury DepartmentJuly 20Auction of 3-month Treasury bills, winning yield3.730%, bid-to-cover ratio of 3; 6-month3.835%, bid-to-cover ratio of 2.94. Demand for short-end Treasuries remains solid, pricing in expectations of no rate move in July.

MondayOvernight reverse repovolume$30 million, ample liquidity conditions persist.

▌ Yield Curve: Analysis of Bear Flattening Characteristics

Last week, U.S. TreasuriesThe curve shows a classicbear flatteningshape. $U.S. 1-Year Treasury Bills Yield (US12M.BD)$ Upward13 basis pointsto4.065%， $U.S. 3-Year Treasury Notes Yield (US3Y.BD)$ Upward14.9 basis pointsto4.368%， $U.S. 5-Year Treasury Notes Yield (US5Y.BD)$ Upward15.3 basis pointsto4.438%， $U.S. 10-Year Treasury Notes Yield (US10Y.BD)$ Upward13.4 basis pointsto4.687%， $U.S. 30-Year Treasury Bonds Yield (US30Y.BD)$ Only upward9.1 basis pointsto5.163%。

The mid-section (3Y-5Y) saw the largest increase, reflecting repricinginterest rate hikeExpected repricing; the long end showed relatively restrained gains, indicatinginflationexpectations remain manageable butterm premiumis still expanding.

The 3s30s spread narrowed by approximately6 basis pointsto79.5 basis points, flattening the curve overall.

Short-end pricingPolicy pathUpward revision; the marginal impact of long-end pricing of stagflation risk is limited.

▌ Historical perspective

1990sGreenspanEra of 'ambiguous communication,' during which the market previously overpricedPreliminary Guidancedue to missing signals.interest rate hikerisks.

Current Waller's'silent policy'is replaying this dynamic,interest rate hikewith expectations becoming less sensitive to individual data points and more focused onPolicy pathThe uncertainty premium has risen.

▌ Scenario Analysis

Scenario 1 (on hold in July): Septemberinterest rate hikeExpect further repricing, short-end yields decline, and the curvesteepens bullishlyrevaluation.

Scenario 2 (Julyinterest rate hike)：policy pathrevised upward, and the curvebear steepeningsteepens further, with long-end yields catching up.

Currently leaning toward Scenario 1, but Waller"Silence policy"has caused Julyinterest rate hikemarginal pricing uncertainty around probabilities to rise.

▌ Other major central bank activities

ECB: Rates held steady, but the Governing Council collectively turned hawkish; Septemberinterest rate hikeexpectations are elevated, with traders pricing in two 25-basis-point hikes before year-end.interest rate hike。

BOJ: Next week's policy meeting is expected to maintaininterest rate hikeits commitment,inflationretains warnings about risks to its above-2% target, though immediate price shock risks have eased compared to April.

BoE: Traders are increasinginterest rate hikebets, fully pricing in cumulative rate hikes by mid-2027.interest rate hike75 basis points.

▌ Market Reaction

last week $Gold Futures (DEC6) (GCmain.US)$ Slight increase0.81%to$4,055.7， $USD (USDindex.FX)$ strengthening0.72%to101.484。

Goldrising in tandem with the US dollar reflectssafe-haven premiumbutreal interest ratesupward movement exerts marginal downward pressure on precious metals.

▌ Closing Remarks

Last weekcore pricing hinges on cooling CPI andinterest rate hikeThe paradox of anticipated repricing, with Waller's"silent policy"steering the market toward path pricing.

Investors should closely monitorthe July 30 FOMCmeeting outcome, the AugustJackson Holesymposium, and the SeptemberFOMC dot plotupdate—these three events will testinterest rate hikeExpected authenticity.

Investors should also note that regardless of whether interest rates are raised or held steady, the current rate level remains historically high and will eventually enter a rate-cutting cycle.

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