Bond Report: 10-year Treasury yield dips back below 3% as traders await European Central Bank decision

What’s driving markets

The Federal Reserve is in its media blackout period before the Federal Open Market Committee meeting that concludes in a week’s time. The dearth of Fed speakers, alongside a thin few days of U.S. macroeconomic data, has left the bond market relatively calm.

Read: U.S. inflation, recession concerns take a back seat in markets to someone else’s problems for now: Europe’s

The MOVE index, a gauge of expected Treasury market volatility, has fallen to 124.7, down from a high of almost 160 earlier this month, as markets recalculate their expectations for the path of Fed monetary policy.

Traders are pricing in a 66.8% probability that the Fed will raise interest rates by another 75 basis points to a range of 2.25% to 2.5% at its July 26-27 meeting. The central bank is expected to take its borrowing costs to a level that’s most likely between 3.5% and 3.75% by next March, according to the CME FedWatch Tool, citing fed funds futures trades.

The only U.S. data release on Wednesday showed that U.S. existing-home sales fell 5.4% to a seasonally adjusted annual rate of 5.12 million in June.

Investors are looking across the Atlantic for some action. The U.K.’s policy-sensitive 2-year gilt yield
TMBMKGB-02Y,
2.060%
was down 4.3 basis points to 1.997%, despite a report showing Britain’s inflation rate came in at a higher-than-expected 9.4%, the most since 1982. On Tuesday, Bank of England Governor Andrew Bailey said that the BoE would consider hiking its benchmark interest rate by a bigger-than-forecast 50 basis points at its next rate-setting meeting in two weeks.

The European Central Bank, according to reports, may also consider raising it benchmark interest rate by 50 basis points at its meeting on Thursday, in order to suppress record eurozone inflation of 8.6%. Such a move would only take the ECB rate to zero, however. The 2-year German bond yield
TMBMKDE-02Y,
0.608%
dipped 4 basis points to 0.591%.

See: Here’s what to watch as the ECB readies its first rate hike in more than a decade

The Germany/Italy 10-year bond spread, a gauge that signals stress in the eurozone, dipped below 200 basis points during morning trading in Europe after Italian prime minister Mario Draghi said he would try to rebuild his ruling coalition. Toward the end of the session, it had widened back up to 209, according to FactSet data.

What strategists are saying

Back in the U.S.,  the June consumer price index report “delivered a broad-based upside surprise, sparking a renewed, albeit short-lived, push for additional frontloading via a 100bp July hike and another leg of curve flattening,” said Credit Suisse’s Jonathan Cohn. “Despite the report giving hawkishly-inclined officials an opportunity to stump for a 100bp move in the last days before the FOMC blackout period, they opted to support the 75bp pre-CPI base case, prompting an unwind of much of the 100bp premium into the July meeting.”

“There may be some recognition that frontloading may have its limits and indeed prove counterproductive when recession fears contribute to overtightening concerns, ultimately bringing down longer-dated yields and, on net, easing financial conditions,” Cohn wrote in a note on Wednesday.