U.S. Treasury yields declined on Tuesday as market participants positioned themselves ahead of the May consumer price index report scheduled for release on Wednesday.
The inflation print follows a stronger-than-expected May jobs report released on Friday, which lifted expectations that the Federal Reserve could tighten policy further later this year. Traders in the fed funds futures market have priced in about a 65% probability of a rate increase by December.
Economists are forecasting that May's consumer price index will show a slowdown in monthly price pressures while annual headline inflation is expected to rise to 4.2% year-over-year. Core inflation, which strips out volatile food and energy components, is projected at 2.9%.
Developments on the geopolitical front also influenced investor flows. Indications that progress may be occurring toward resolving the conflict with Iran have reduced some upward pressure on inflation expectations and supported demand for U.S. Treasury securities.
However, yields were briefly pushed higher after U.S. President Donald Trump announced that Iran had shot down a U.S. Apache helicopter patrolling the Strait of Hormuz overnight and said he would respond. That announcement produced a short-lived move in markets before Treasuries resumed their decline.
The 2-year Treasury note yield, which is often used as a barometer of Federal Reserve policy expectations, fell 3.1 basis points to 4.127% on Tuesday.
Market participants will be watching Wednesday's CPI release closely for confirmation of whether monthly price pressures have eased and to see the trajectory of annual inflation. The data are likely to influence the probability assigned by traders to further Fed tightening this year and to shape demand for government debt in the near term.
Summary of the market context:
- May payrolls surprised to the upside, raising the odds of a December rate hike to about 65% as reflected in fed funds futures.
- Economists expect headline CPI to increase to 4.2% year-over-year and core CPI to measure 2.9%.
- Geopolitical signals around Iran briefly pushed yields higher but overall supported Treasury demand as tensions showed signs of possible de-escalation.