Inflation cooling weakens expectation of rate hike in July, US treasury bonds rose slightly this week.

The U.S. Treasury market rose slightly this week, as cooling inflation data boosted market sentiment, offsetting the pressure from a sharp rebound in international oil prices. Traders significantly reduced their bets on a Fed rate hike in July as a result. However, the soaring oil prices and continued hawkish signals from Fed officials have kept expectations for another rate hike by the end of the year alive. This week's release of the U.S. Consumer Price Index (CPI) and Producer Price Index (PPI) both showed easing inflation pressures, leading to an overall decline in U.S. Treasury yields. Short-term treasuries, which are most sensitive to monetary policy, performed the best, with the largest yield declines. However, the sharp increase in international oil prices limited the gains in the bond market, as investors still believe that rising energy prices could reignite inflation and prompt the Fed to continue tightening monetary policy later this year. Molly Brooks, U.S. interest rate strategist at TD Securities, stated that after the release of inflation data this week, the market noticeably lowered expectations for further Fed rate hikes, especially considering the significant decrease in the probability of a rate hike in the near term. Interest rate swaps markets indicate that traders currently expect a 25 basis point rate hike by the Fed at the July 28-29 meeting to have decreased from around 50% to about 15%. With no significant economic data scheduled for release before the meeting and Fed officials entering the pre-meeting "quiet period," the room for further adjustments to policy expectations for July is limited. As a result, the yield on the 2-year U.S. Treasury note fell by 3 basis points this week, reaching 4.18%. However, there is still considerable disagreement in the market regarding the Fed's medium- to long-term policy path. Recently, there has been increased support within the Fed for further rate hikes, with even some previously dovish officials adopting a more hawkish stance. Cleveland Fed President Loretta Mester indicated on Friday that given the resilient consumer spending and low unemployment rate, persistently high inflation remains a bigger concern for her at the moment. Dallas Fed President Robert Kaplan also suggested on Thursday that the U.S. may need to "modestly raise rates" as there is currently insufficient evidence that inflation will sustainably fall back to the Fed's 2% target level. Both Mester and Kaplan were already more hawkish members within the Fed, with both opposing any signals of future rate cuts in the April monetary policy statement. Moreover, escalating tensions in the Middle East have once again pushed up energy market risk premiums. This week, the U.S. launched a new round of military strikes against Iran, causing significant volatility in international oil prices. U.S. West Texas Intermediate crude oil futures closed at $82.49 per barrel on Friday, up nearly 16% for the week and reaching the highest level since June 12. Despite the recent improvement in U.S. inflation data weakening short-term rate hike expectations, the rebound in energy prices combined with the continuous hawkish comments from Fed officials suggest that bets on another rate hike later this year have not completely disappeared. The future path of Fed policy will continue to depend on inflation trends and changes in energy prices.