Long-term US Treasury pressure remains after US PCE data: 30-year yield nears 5.2%, yield curve steepens

The Federal Reserve's decision to keep interest rates unchanged this week continues to stir the bond market. Long-term US Treasury yields remain elevated following the release of the latest economic data, as persistent inflation and resilient employment make market judgments on future rate hikes more divided, with the steeper yield curve driving rising demand for safe-haven assets.

The 30-year US Treasury yield surged more than 10 basis points on Wednesday to the highest level since 2007 and stayed near 5.20% on Thursday.

The US released June PCE Price Index data on Thursday, showing a 0.1% decline month-on-month, marking the first negative monthly growth since 2020. The year-on-year increase narrowed to 3.7% from 4.1% in the previous month. Core PCE, excluding energy, slowed slightly from 3.4% to 3.3% year-on-year, rising just 0.1% month-on-month, below the market expectation of 0.2%.

In addition, oil prices, which had retreated in June, rebounded after the US resumed military actions against Iran, intensifying market concerns over Middle East supply risks.

Interest rate swaps show the probability of a 25 basis-point Fed rate hike in September is now about two-thirds, lower than the completely priced-in level seen before the recent Fed decision.

After the Fed stood pat, long-term US Treasury yields have struggled to retreat, with persistent inflation concerns providing main support.

The 30-year breakeven inflation rate—a measure of market inflation expectations—jumped 6 basis points on Wednesday alone, the largest single-day gain since the day after Trump won the 2016 presidential election.

Oil prices rose again after the US restarted military strikes on Iran, with the resulting uncertainty in Middle Eastern supply further boosting inflation expectations.

Danske Bank A/S chief analyst Jens Peter Sorensen commented:

"If inflation does not slow down, there’s further upside risk for long-term bond yields. The market can only guess how many more hikes are needed, and the timing might be later than currently expected."

In contrast to the long end, short-term US Treasury yields continued to fall on Thursday, with 2-year to 5-year yields dropping around 5 basis points to weekly lows.

This was partly influenced by the UK market—as UK gilt traders scaled back bets on a September rate hike following the Bank of England meeting, which led to lower gilt yields. The Japanese yen also rose over 3% against the US dollar in a single day, providing further support for shorter-term US yields.

As a result, key yield spreads widened further, climbing to the highest level since May: the spread between 2-year and 10-year yields approached 45 basis points, while the spread between 5-year and 30-year yields expanded to 84 basis points, with the yield curve continuing to steepen.

The steepening trend in the curve has triggered notable hedging activity in derivatives markets, with investors using Treasury options to seek protection against further increases in long-term yields.

On Thursday, a $13 million options trade was seen, betting that the 10-year Treasury yield would climb to 4.80%—the high from last year—within weeks.

On Wednesday, a large September Treasury futures options trade targeted a 30-year yield of about 5.3% within weeks. Both of these options expire on August 21.

Fed Chair Powell’s decision to stand pat this time has sparked doubts in the market about his commitment to fighting inflation, increasing uncertainty about the path of rate hikes.

Apollo Global Management chief economist Torsten Slok said in an interview:

"We need to discuss the credibility of the committee—words alone are not enough; ultimately, actions must be taken."

Previously, the market assigned about a 40% chance to a rate hike at this Fed meeting, as a demonstration of Powell’s anti-inflation stance, but this expectation was not met. Current swap market pricing shows the probability of a rate hike in September has declined, and the likelihood of two hikes this year has been cut to about 40%, down from roughly 80% before.