A weaker-than-expected US inflation reading has prompted a sharp repricing across interest rate markets, with hedge funds and other fixed income investors reducing expectations that the Federal Reserve will raise rates at its July meeting, according to a report by Bloomberg.
US Treasuries rallied following June’s consumer price index (CPI) report, which showed prices fell for the first time in six years. The move pushed the yield on the policy-sensitive two-year Treasury around nine basis points lower to 4.19%, while derivatives markets dramatically reduced the implied probability of a July rate increase.
Interest rate futures now imply less than a 17% chance of a rate hike later this month, down from around 40% before the inflation data was released. Attention has instead shifted to the Federal Reserve’s September and October policy meetings, with investors continuing to assess whether inflationary pressures will re-emerge.
Molly Brooks, US rates strategist at TD Securities, said the inflation report had eased immediate concerns over tighter monetary policy but cautioned that future economic data would remain critical.
The latest repricing follows a period in which hedge funds and other speculative investors had been positioning for a more hawkish outcome. Fed funds futures had seen a sharp increase in activity over recent weeks after comments from Federal Reserve Governor Christopher Waller and rising oil prices fuelled expectations that policymakers could tighten policy again in July.
Open interest in August Fed funds futures, which settle against the outcome of the Fed’s July meeting, has roughly doubled since the beginning of June, reflecting growing participation and an increase in bearish interest rate positions.
Data from the Commodity Futures Trading Commission also showed leveraged funds had built their largest net short position in rate markets since September before the CPI release, highlighting the extent to which investors had anticipated higher yields.
Despite the softer inflation reading, markets remain cautious about the outlook. Renewed conflict around the Strait of Hormuz has pushed Brent crude back towards $86 a barrel, almost 20% above levels seen earlier this month, raising concerns that higher energy prices could reignite inflation.
As a result, traders continue to expect further monetary tightening later this year, with derivatives markets largely pricing in a rate increase by October.
Damien McColough, head of fixed income research at Westpac Banking Corp, said the renewed escalation in the Gulf underscored the uncertainty surrounding inflation and interest rates.
He said ongoing geopolitical risks were likely to maintain upward pressure on bond yields across the curve until there is greater clarity on the outlook for energy markets and global growth.
Positioning data also suggests investors have become less aggressively bearish in recent days. JPMorgan’s latest Treasury client survey showed outright short positions declined to their lowest level since April, while long positions increased modestly.
Meanwhile, activity in SOFR options has remained elevated, with traders concentrating on call structures tied to expectations for the path of US interest rates over the remainder of 2026.
