August 1, 2019 / 10:10 PM / 16 days ago

Fed's mild rate turn crushes U.S. inflation expectations

NEW YORK (Reuters) - U.S. investors’ inflation expectations were hammered on Thursday, a day after the U.S. Federal Reserve cut interest rates for the first time since 2008, while Chairman Jerome Powell signaled the central bank has not entered an outright easing cycle.

FILE PHOTO: Federal Reserve Board building on Constitution Avenue is pictured in Washington, U.S., March 19, 2019. REUTERS/Leah Millis/File Photo

U.S. President Donald Trump’s threat of more tariffs on Chinese goods further eroded investors’ confidence on whether domestic inflation would ever reach the Fed’s 2% goal, analysts said.

The U.S. bond market’s gauges of investors’ inflation outlook tumbled to their lowest levels in about 6-1/2 weeks.

“They were disappointed. They didn’t feel the Fed had their back,” said Gennadiy Goldberg, senior interest rates strategist at TD Securities.

Powell at a news conference on Wednesday following a two-day policy meeting said, “Let me be clear – it’s not the beginning of a long series of rate cuts.”

In late trading, the yield spread between 10-year Treasury Inflation Protected Securities, or TIPS, and 10-year Treasury notes was 1.691%, down 8 basis points from Wednesday, according to Tradeweb and Refinitiv data. US10YTIP=TWEB US10YTIP=RR

The 10-year breakeven rate on Thursday touched 1.682%, the lowest level since June 17.

The five-year breakeven rate hit 1.474%, which was also the lowest since mid-June. It finished at 1.483%, down over 9 basis points on the day.

Powell and a number of Fed officials have raised concerns about stubbornly low inflation, which would be a factor for them to consider lowering interest rates.

Some traders had even bet on the central bank cutting rates by half a point on Wednesday instead of the quarter point move the Fed implemented.

“It’s with the Fed under-delivering,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale.

Still the interest rates market suggested a high likelihood the Fed would lower rates at its next meeting in September.

Interactive graphic: U.S. Fed's next rate cut - tmsnrt.rs/2yrEpbn

In addition to their disappointment over the Fed’s mild turn, TIPS holders were wrong-footed by Trump’s threat to impose an additional 10% tariff on $300 billion worth of Chinese imports starting on Sept. 1, even as trade talks between the world’s two biggest economies continue.

Trump’s announcement compounded worries about global trade and inflation. It also sent U.S. benchmark crude prices down 7%, marking their biggest one-day drop in more than four years.

Energy prices are major factors for investors calculating their inflation outlook.

Graphic: U.S. 5-year, 5-year forward breakeven inflation rate interactive - tmsnrt.rs/2PdzVzO

Reporting by Richard Leong; editing by Jonathan Oatis

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