CPI Fades into Background as Fiscal Deficit Takes Center Stage

The upcoming US CPI inflation data on Wednesday may not be as crucial for Treasuries as some market participants think, according to ING Think.

The focus has been on the impact of inflation on real returns from bonds, but the market is already pricing in a mild inflation landing. Market break-even inflation rates are running below 2.5%, and core CPI is anticipated at 2.5% year-over-year in July, which would be considered fine.

However, the bigger concern for Treasuries may be the fiscal deficit, which has been steady despite some recent fluctuations. The US Treasury Secretary's compensation package, as reflected in the 10yr swap spread, has managed to hold steady at around 40bp since May.

But with the July fiscal number expected to confirm a deterioration in the deficit, there is a risk of seeing a wider 10yr swap spread. This could be due to a reevaluation of credit risks, potentially pushing the spread towards 50bp on a multi-month view.