"The anchor of global asset pricing" is reaching a critical moment! If the US CPI brings a dovish surprise, short covering in US Treasuries may boost the rally in risk assets.

Wall Street strategists are almost more divided than ever on whether the Federal Reserve will choose to resume interest rate hikes next month. However, one thing is undisputed: the U.S. CPI inflation report released on Wednesday will largely determine the Fed's next move. According to swap market trading conditions, traders are currently pricing in a roughly 50% chance of a 25 basis point rate hike. Following the unexpected weakening of non-farm payrolls in July, Wall Street has almost created a 50:50 extreme split pricing on whether the Fed will hike rates by 25bp in September. Under the leadership of Warsh, the Fed has significantly reduced forward guidance, forcing the market to rely on hard data to determine policy direction. As a result, the impact of Julys CPI has a distinctly asymmetric characteristicmild inflation data could further weaken the rationale for rate hikes, but hotter-than-expected data could more easily turn the rate hike in September back into the baseline scenario. For the 10-year U.S. Treasury yield, often termed the "anchor of global asset pricing," the current bond market risk-reward has noticeably tilted toward a pricing direction of "July's mild CPI drives yields sharply lower," primarily driven by positive resonance between macro data and CTA bond market positions. There is a very dangerous convexity signal in the current bond market, or a position amplifier: a compilation by UBS indicates that CTA funds' underweight positions in bonds had expanded to three times the size from two weeks ago by the end of July, with each 1bp movement in the 10-year U.S. Treasury yield affecting the P&L of CTA strategies by about $300 million, the highest since 1990 for which data is available. Therefore, if core CPI hovers around the 0.15%0.20% range, the market will not only lower the probability of a September rate hike but may also trigger a mechanical feedback loop of "falling yieldsCTA stop-loss buying back bondsfurther declining yields." If the 10-year U.S. Treasury yield, known as the "anchor of global asset pricing," continues to decline, it would be a significant positive catalyst for risk assets such as global equities that are staging a comeback. Inflation data takes the lead in market trading, with CPI as the "deciding factor" for the September rate hike. Molly Brooks, a U.S. market interest rate strategist at TD Securities, stated that if inflation data comes in significantly higher than market consensus, the probability of a Fed rate hike could rise sharply; conversely, if there is another mild inflation reading, it would provide policymakers with more room to wait. Brooks stated, We believe this data is crucial for September. She added that the market reaction is likely to be asymmetricif the data exceeds expectations, its impact on the likelihood of a rate hike will far outweigh the influence of data falling below expectations. Economists consistently expect that core CPI will increase slightly by 0.2% month-on-month, following a previous reading that unexpectedly decreased by 0.4%. Bloomberg Economics forecasts that the year-on-year growth rate of core CPI in July will fall to 2.4%, indicating a potential reach for the lowest level since March 2021. On Wednesday, prior to the U.S. stock market opening, U.S. Treasury prices showed little change as the market awaited the inflation report. The benchmark 10-year U.S. Treasury yield fell by 1 basis point to 4.68%, while the 30-year yield dropped to 5.23%. As shown in the chart above, swap market traders are aggressively pricing in the Fed's next moves. Some U.S. Treasury traders believe that the market's pricing of the Fed's hawkishness has exceeded what the economic fundamentals can support, hence betting that the upcoming data will force the market to reassess this view. Ruben Hovhannisyan, fixed income portfolio manager at TCW Group, noted, We expect a bull steepening of the curve as the front end of the yield curve's extreme hawkish pricing is unwound. He stated, Our overweight position is primarily concentrated at the front end of the yield curve. However, recent data have also shown how quickly the economic landscape can change. The CPI report released last month showed inflation decreasing for the first time since 2020, prompting two-year U.S. Treasury yields to fall by as much as 14 basis points. The employment report released last week indicated that U.S. employers unexpectedly reduced jobs in July, leading traders to further adjust downwards their expectations for Fed rate hikes this year. Goldman Sachs interest rate strategists stated in a report last Friday that a slowdown in job growth "may raise the threshold that core CPI needs to reach" in order to make a September rate hike "the outcome that markets see as most likely." In recent weeks, several Fed policymakers, including Dallas Fed President Lorie Logan and Minneapolis Fed President Neel Kashkari, have publicly warned of the risks of potentially having to take more aggressive policy measures if action against inflation is delayed. Kelsey Berro, a portfolio manager in JPMorgans Asset Management division, remarked, The real story now is inflation, not the labor market. She added, This is an unusual situationeconomy is still in an expansion phase, but core PCE is running noticeably hotter than all other indicators. Berro believes that the front-end pricing of the U.S. Treasury yield curve is currently reasonable regarding potential rate hikes, and if Wednesdays CPI data comes significantly higher than market expectations, it will further increase the probability of a September rate hike and stoke market bets on imminent rate increases. As Fed Chair Warsh aims to reduce the central bank's early disclosure of future policy intentions, breaking away from the practice of signaling policy intentions ahead of formal decisions, the importance of economic data has significantly risen again. After the Fed maintained interest rates last month, long-term U.S. Treasury yields surged to their highest level in nearly 20 years. Bilal Hafeez, founder and market strategist at Macro Hive, commented, The market is telling the Fed it has an inflation problem, but the Fed currently views recent data as soft enough not to warrant a rate hike yet. Given the extreme negative positioning right now, and the substantial rise in yields seen this quarter, even if the long-term outlook for U.S. Treasuries remains bearish, the long-dated bonds might be more favorable for a tactical rebound, from a risk-reward perspective, said Ven Ram, multi-asset strategist at Bloomberg Strategists. George Catrambone, head of fixed income at DWS Americas, expects the CPI report will provide clearer guidance for future monetary policy outlook than the upcoming Jackson Hole Global Central Bank Symposium later this month. Catrambone stated, The threshold for overall CPI to fall back into negative growth is quite high, but after weak non-farm payroll data, as long as core CPI does not rise more than 0.2% month-on-month, it should be sufficient for the Fed to remain on hold. He added, The market may find it challenging to comprehend Warsh, but data should be more persuasive than any hawkish or dovish rhetoric from Jackson Hole. DWS prefers to hold U.S. Treasuries with maturities of two to five years, as the firm expects the Fed will choose not to raise rates this year. Catrambone added, The yield curve between the federal funds rate and two-year and five-year Treasuries is quite steep, so this segment looks very attractive for investment. Record short positioning in CTAs meets cooling inflation; the bond market could become a new booster for global risk assets. The 10-year yield, prior to the CPI announcement, was around 4.68%, reflecting a considerable extent of pricing tied to "higher for longer + potential reinstatement of rate hikes + fiscal term premia + oil price risks"; whereas Goldman Sachs believes the exceptionally weak CPI in June, although partly coincidental, should lead to progressively softer monthly inflation due to diminishing tariff pass-through, easing effects from certain conflicts, and shrinking statistical impact related to AI, with the most significant upside risk still being oil prices. A compilation by UBS shows that CTA funds underweight positions in bonds had expanded to three times the size from two weeks ago by the end of July, with a 1bp movement in the 10-year U.S. Treasury yield affecting the P&L of CTA strategies by about $300 million, the highest since 1990 for which data is available. Therefore, if core CPI hovers around the 0.15%0.20% range, not only would the market lower the probability of a September rate hike, but it might also trigger a mechanical feedback loop of "falling yieldsCTA stop-loss buying back bondsfurther declining yields." If the 10-year U.S. Treasury yield continues to decline, it would act as a significant positive catalyst for the global equity markets that are staging a resurgence. Continued declines in U.S. Treasury yields are particularly important for the rebounding global equity markets, as the CPI announcement tonight will not only determine the markets outlook for the Feds monetary policy path but will also decide whether the risk-free discount rate in global stock valuation models continues to rise or reaches a turning point. The U.S. stock market just experienced a strong rebound: for the week ending August 7, the S&P 500 rose 3.58% and the Nasdaq 5.19%, with the S&P renewing its historical highs; at the same time, 85.1% of the 436 S&P 500 companies that reported earnings exceeded expectations, indicating that the current stock market is not simply relying on valuation expansion but is bolstered by strong earnings. Thus, if tonight's data shows a combination of core CPI significantly below 0.2% + employment has weakened, but profits have not collapsed, it would be almost equivalent to the market's most favored "Goldilocks" pricing scenario: declining 10-year U.S. Treasury yieldslower stock risk premium pressurehigher present value of long-term cash flowshigh-duration AI tech, software, small-cap growth, REITs, and Asian emerging markets continuing to experience valuation recovery, while the decline in the dollar's interest rate advantage further improves global financial conditions. If core CPI is below approximately 0.2%, the current global stock market may welcome a rare trifecta of fundamentals + policy expectations + positioning technicals; conversely, if it significantly exceeds 0.25%, then the 10-year U.S. Treasury yield, the "anchor of global asset pricing," would tighten global financial conditions again, and put pressure on the valuation of risk assets that have just recovered near historical highs. From a theoretical perspective, the 10-year U.S. Treasury yield serves as the risk-free interest rate in an important valuation modelDCF (Discounted Cash Flow)in the stock market model. If there are no significant changes to other indicators (especially expected cash flows on the numerator side)as seen during earnings season, where the numerator side is in a vacuum due to a lack of positive catalystsan elevated or historically high denominator level will pose collapse threats to the valuations of risk assets closely related to AI, high-yield corporate bonds, and cryptocurrencies. The latest scenario analysis from JPMorgans trading desk indicates that if the core CPI data falls between 0.15% and 0.20%, the S&P 500 is expected to rise by about 0.5% to 1%; even in the baseline range of 0.20% to 0.25%, its still expected to rise by approximately 0.25% to 0.75%. However, JPMorgan anticipates that if core CPI falls between 0.25% and 0.30%, the S&P 500 might decline by about 0.5% to 1.25%. This is why the greatest potential market event derived from this data is not necessarily the CPI itself, but the rapid loosening of global financial conditions created by the combined effects of cooling inflation + unwinding of hawkish pricing + record short covering in bonds.