TheStreet

U.S. Treasury bond yields extended their seemingly-relentless rise Friday, taking benchmark notes to the highest levels since late July and adding a further layer of complexity to next week's Federal Reserve rate decision.  

Benchmark 10-year Treasury note yields topped the 1.83% mark in early European trading Friday, the highest since July 25 and a move that extends their two-week increase to around 40 basis points, an astonishing gain give the market's assumption of a 25 basis point rate cut from the Fed next week, and the probability of further cuts to come in either October or December. Yields on benchmark 2-year notes, meanwhile, have risen 33.6 basis points over the past two weeks to Friday's levels of 1.736%.

Portions of Friday's move were linked to a stronger-than-expected reading for August retail sales, which rose by 4.2% from last year, but also -- and more curiously -- followed yesterday's decision by the European Central Bank to resume its controversial quantitative easing program with €20 billion in monthly bond purchases, for an opened-ended period of time, in order to stoke inflation closer to the 2% level across the region's moribund economy.

Benchmark 10-year German bund yields, however, were marked 15 basis point higher than yesterday's levels, and trading at a six week best of -0.52%, in early Friday dealing suggesting investors are either prepared to take profits from the ECB decision or are finally willing to assume that faster inflation -- which makes bond less attractive -- is somewhere on the horizon.

Faster inflation certainly appears to have finally arrived in the United States, where core consumer prices spiked to a decade high of 2.4% last month as the nations jobless rate holds at 50-year lows, average hourly wages continue to grow and the economy hums along at a 2% run-rate. 

"The third straight 0.3% increase in the core CPI- that hasn't happened since 1995-was ignored by the Treasury market yesterday, which appeared to be focusing its attention on the ECB," said Pantheon Macroeconomics Ian Shepherdson. "But it matters. We doubt the trend in the c ore CPI is now as a high as 0.3% per month, which ultimately would generate a 3.7% core inflation rate-but we are convinced it is rising."

"And it will increase further over the next few months as retailers begin to pass-on the 15% tariffs on imported Chinese consumer goods," he added.

European Central Bank, acting quickly, Cuts Rates 10 Basis Points. They are trying, and succeeding, in depreciating the Euro against the VERY strong Dollar, hurting U.S. exports.... And the Fed sits, and sits, and sits. They get paid to borrow money, while we are paying interest!

— Donald J. Trump (@realDonaldTrump) September 12, 2019

What it may also do is complicate the debate surrounding the Fed's presumed 25 basis point rate cut, which the CME Group's FedWatch tool suggests sits at around 88.8%. Fed Chair Powell has been under intense pressure from President Donald Trump to lower rates, which he says inflate the value of the dollar and put U.S. exporters at a competitive disadvantage in global trade.

Others, however, suggest the President is far more focused on the impact rate cuts will have on stock prices, and the political capital record-high indices will give him heading into next years's elections. 

"Keep in mind that the Fed's preferred CPI measure remains still well below 2%," said Saxo Bank's head of equity strategy Peter Garnry. "But if inflation is showing its face while the dollar is historically strong then the Fed will have to make difficult choice."

"Should hold rates due to domestic economic situation and risking a strong dollar killing global growth?," he asked. "Or does it cut rates to ease financial conditions and help the global economy, but risking accelerating inflation with all its consequences?."