Market Extra: Bonds have biggest one-day rally in more than a decade after October’s downside inflation surprise

Investors cheered one of the few pieces of good news about U.S. inflation in the past year and sent Treasurys to their biggest one-day rally in more than a decade on Thursday.

Strong demand for government bonds pushed the two-
TMUBMUSD02Y,
4.323%
and 10-year Treasury yields
TMUBMUSD10Y,
3.819%
down by 30 basis points or more. Those were the biggest one-day declines for the two- and 10-year rates since Sept. 29, 2008, and March 18, 2009, respectively, according to 3 p.m. figures from Dow Jones Market Data.

The euphoria over Thursday’s consumer-price index for October extended across stocks, where Dow industrials finished up by 1,201.43 points, but the report took the steam out of the dollar
DXY,
-2.36%.
Meanwhile, traders gave greater credence to the idea that the Federal Reserve may move away from aggressive interest rate hikes in December.

See also: U.S. inflation has come off the boil, but it’s going to take a lot longer to cool down

Among other things, the CPI data showed the annual headline inflation rate falling below 8% for the first time in eight months and included other readings which came in below expectations. Financial markets haven’t seen this much good news about inflation in the past year, with the exception of July’s downside surprise.

“It’s hard to read too much into one print,” said Subadra Rajappa, head of U.S. rates strategy at Société Générale in New York. “That said, this feels like a step in the right direction, but it’s too early to call for a sustained rally in bonds.” 

“This feels a bit like a relief rally because so much news has been on the bearish side,” she said via phone Thursday. “It represents one day’s reaction in a relatively illiquid market. The broader tone from the Fed is likely to be a downshift, not a pause or pivot, in rate hikes. So the Fed is probably going to stay on course and deliver more hikes, at least into early next year. What we need to see is several prints pointing toward lower inflation. There won’t be a pivot on the policy front anytime soon.” 

See: Fed’s Harker backs slower pace of interest-rate hikes

Indeed, fed-funds futures traders boosted the chances of a half-percentage-point rate hike in December to 85%, up from 57% on Wednesday — which would lift the Fed’s main policy rate target to between 4.25% and 4.5%. They also factored in a greater likelihood of the fed funds rate target getting to between 4.75% and 5% in the first half of next year, instead of 5% to 5.25%.

Treasury yields plummeted on Thursday, with the 2-year rate
TMUBMUSD02Y,
4.323%
finishing the New York session at 4.3%, the 10-year rate
TMUBMUSD10Y,
3.819%
at 3.8%, and the 30-year rate
TMUBMUSD30Y,
4.057%
at almost 4.1%. Meanwhile, all three major stock indexes
DJIA,
+3.70%
SPX,
+5.54%
ended sharply higher, led by a 7.4% jump in the Nasdaq Composite. It was the Nasdaq’s best performance on a CPI-release day on record.

This week’s flight to quality in bonds began on Tuesday as signs of trouble emerged in the crypto world. It continued in some Treasurys, such as the policy-sensitive 2-year note, on Wednesday as massive layoffs began at Meta Platforms Inc.
META,
+10.25%
and reinforced the sense that the Fed’s tighter policies were finally resulting in a destruction of demand in the U.S. economy.

Though Thursday’s signs of decelerating inflation were expected and the U.S. may have moved past the peak of price gains, “the pace at which inflation is declining is still very slow,” said Nancy Davis, founder of Quadratic Capital Management in Greenwich, Conn. and a portfolio manager for the Quadratic Interest Rate Volatility and Inflation Hedge Exchange-Traded Fund 
IVOL,
+1.79%.

“Historically, fixed income has been a safe haven for most market shocks,” Davis wrote in an email. “But the era of ultra-cheap money which provided a tail wind for bonds for the past few decades appears finally to be ending. With inflation running so hot, purchasing power is eroding rapidly. We continue to urge investors to look beyond vanilla bonds and stocks for assets that aren’t correlated with everything else that they own.”