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(Bloomberg) — Bond investors lifted wagers that the Federal Reserve will cut interest rates by a quarter point next month as a sharp rise in claims for unemployment took precedence over a hotter-than-expected inflation print.

The move signals confidence that the US central bank will keep lowering rates despite last week’s strong labor-market report. Swaps traders boosted to well over 80% the probability the US central bank will opt for a 25-basis-point reduction in November. For all of 2024, traders now see a total of 45 basis points of rate cuts, slightly more than prior to Thursday’s round of economic data.

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“What has continued to be really important is the labor market,” Greg Peters, co-chief investment officer at PGIM Fixed Income, said on Bloomberg Television. “Inflation is still last year’s story. Yeah, there was an upside surprise there, but at the end of the day, it’s about labor, labor and labor.”

Treasuries whipsawed after the data releases. Two-year Treasury yields, more closely tied to Fed rate decisions than longer tenors, wiped out an earlier advance to fall as much as 7 basis points to slide below 4%. Meanwhile, the 10-year yield rose as much as around 3 basis points to about 4.10%, its highest since late July.

Leading into the data, de-leveraging of long positions in futures and the build-up this week of fresh bets on US bond losses left the Treasuries market more open to covering demand, a potential factor behind the front-end led rally in the aftermath of a weak weekly jobless claims print.

The underperformance in long-term Treasuries, which sees a greater hit from inflation, sparked a sharp steepening of the yield curve. The gap of two-year yield above those on debt with 10 years to maturity expanded about 6 basis points to 11 basis points. On Monday, short-term rates had briefly dipped back below long-term, putting the curve temporarily back into an inverted position.

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Also putting pressure on long-term debt was likely positioning ahead of the Treasury’s sale of $22 billion of 30-year bonds on Thursday. That followed a sale of 10-year debt on Wednesday and 3-year bonds the day before. 

Following the prints, Federal Reserve Bank of Chicago President Austan Goolsbee reaffirmed that the central bank has moved beyond its singular focus of inflation.

The so-called core consumer price index — which excludes food and energy costs — increased 0.3% for a second month, disrupting a string of lower readings. A separate report showed that applications for US unemployment benefits rose last week to the highest in over a year — reflecting large increases in Michigan, as well as states affected by Hurricane Helene.

“The September CPI report came in stronger than expected, with core CPI in particular surprising to the upside,” said Whitney Watson, global co-head of fixed income and liquidity solutions at Goldman Sachs Asset Management. “Labor market data, however, remains in the driving seat for the Fed and we see next month’s payrolls release as the more important data point in determining the pace and extent of Fed easing.”

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What Bloomberg Strategists Say…

“The data as a whole sends a mixed signal, as traders balance labor market concerns with sticky inflation, trying to gauge which the Fed will prioritize.”

— Nour Al Ali, macro strategist. See more on MLIV. 

Still, despite the ginning up of bets Thursday for a quarter-point move, Fed minutes released Wednesday reinforced exceptions that the central bank’s half-point reduction at their meeting last month was more of a one-off event than a trend for the rest of the year.

The minutes showed Fed Chair Jerome Powell got some push back on the half point reduction with a preference among some officials to cut rates at a more gradual pace.

The latest inflation read, however, does signal the risk that the Fed does not fully have price pressures under control, “at the same time you are looking at a labor market that is perhaps not as strong as the payrolls report last week led us to believe,” Victoria Fernandez,  chief market strategist at Crossmark Global Investments told Bloomberg Television.

“This does give you a little bit of room in the market to maybe pick up some yield in that short end of the bond market,” Fernandez said.

—With assistance from Edward Bolingbroke.

(Updates yield moves throughout and adds futures positioning data.)

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