On July 14, the US bond market underwent a dramatic repricing.
Data released by the US Bureau of Labor Statistics showed that the Consumer Price Index (CPI) for June fell by 0.4% month-over-month—marking the first decline since the onset of the COVID-19 pandemic in May 2020 and the first monthly drop in six years. Year-over-year, June’s CPI growth slowed to 3.5%, significantly lower than May’s 4.2%. The core CPI, which excludes food and energy, was flat month-over-month and rose 2.6% year-over-year. Both figures came in below market expectations.
Following the release, the yield on the 2-year US Treasury—a benchmark most sensitive to monetary policy—plunged by 14 basis points intraday to 4.14%, the largest single-day drop since August last year. By the close, the 2-year yield stood at 4.193%, down 7.76 basis points on the day. Meanwhile, the 10-year Treasury yield fell by 2.61 basis points to 4.591%, and the 30-year yield edged down 0.11 basis points to 5.104%.
The sharp decline in short-term yields reflects a profound shift in market expectations for the Federal Reserve’s policy trajectory over the next 6 to 24 months.
How Cooling CPI Is Shaping Rate Expectations
The unexpected cooling in June inflation was primarily driven by a steep drop in energy prices. Data showed that gasoline prices fell 9.7% month-over-month, and overall energy prices declined 5.7%—the largest monthly drop since April 2020. The fall in energy prices effectively offset increases in housing, food, and other category indices.
In previous months, market concerns about inflation centered on three areas: the AI investment boom potentially overheating demand, escalating tensions in the Middle East driving up energy prices, and tariff policies affecting goods prices. However, June’s data indicate that inflation is moving toward the Fed’s 2% target. The year-over-year increase in core CPI eased from 2.9% in May to 2.6%, signaling that underlying inflationary pressures are moderating.
The immediate impact of cooling inflation is a sharp drop in market expectations for Fed rate hikes. According to CME Group’s FedWatch tool, the probability of a July rate hike was close to 50% before the data release, but plunged to 15.5% after. The probability of holding rates steady jumped to 84.5%. Still, the market expects the Fed may act in September, with a combined probability of a 25 or 50 basis point hike reaching 57.8%.
The Fed’s Hawkish Stance vs. Bond Market’s Dovish Pricing
On the same day the CPI data was released, Fed Chair Kevin Walsh delivered the semiannual monetary policy testimony before the House Financial Services Committee. The new Fed chair took a notably hawkish stance—stating in his written remarks that "the entire committee will not tolerate persistently elevated inflation," and that the Fed has "zero tolerance for sustained high inflation."
Walsh stressed that a single month’s improvement in inflation data does not mean the problem is solved. He also noted that the Fed has two policy tools—interest rates and the balance sheet—and will decide how to use them based on economic data. Importantly, Walsh did not provide any hints about the future path of rates, contrary to market hopes.
This creates a noteworthy divergence: Fed officials are signaling hawkish discipline and unwavering inflation targets, while bond market traders are betting on a policy shift toward easing, based on inflation trends, labor market changes, and economic growth pressures.
Nonfarm payroll data supports this view. Early July figures showed that only 57,000 jobs were added in June—far below expectations—and the previous number was revised down by 74,000. Although the unemployment rate fell to 4.2%, part of the drop was due to labor force participation declining to 61.5%, meaning more people left the workforce rather than found jobs. The marginal weakening in the labor market provides a fundamental basis for easing expectations.
Markets typically anticipate Fed moves. While rate futures pricing reflects a pause in July, there’s still about a 70% chance of at least one rate hike before year-end. The bond market is not trading on a confirmed rate-cut cycle, but on the rising possibility of a policy shift.
Yield Curve Changes: What the Signals Mean
A key feature of this yield move is that short-term yields fell much more than long-term yields. The 2-year Treasury yield dropped 7.76 basis points, while the 30-year fell only 0.11 basis points. As a result, the spread between 2-year and 10-year Treasuries widened; as of July 15, the 2s10s spread reached about 39.6 basis points.
This "short-end decline and curve steepening" pattern typically points to two macro narratives.
The first narrative is that "soft landing" is regaining consensus. If inflation continues to cool without triggering a recession, the Fed gains room to cut rates. Falling short-term yields reflect fading rate hike expectations, while stable long-term yields suggest the market isn’t pricing in a deep recession. This is characteristic of a "soft landing" trade—markets believe the Fed can ease policy without causing an economic collapse.
The second narrative involves liquidity dynamics for risk assets. Lower rates affect risk assets in two ways: first, declining risk-free rates boost the relative appeal of risk assets; second, easing expectations improve dollar liquidity, raising risk appetite.
After the July 14 data release, this logic was validated across markets. All three major US stock indices closed higher: the S&P 500 rose 0.4% to 7,543.59, and the Nasdaq Composite jumped 0.9% to 26,107.01. The dollar weakened against major currencies, with the Dollar Index falling to 100.7.
Crypto markets reacted even more directly. Bitcoin broke above $64,000 on strong trading volume, reaching a high near $65,000 and rising over 4% on the day. Ethereum performed even better, up more than 6% to around $1,890. On-chain data showed nearly 70,000 traders were liquidated in the past 24 hours, totaling $345 million. There was a wave of short positions being forcibly closed, with over $370 million liquidated across the network in 24 hours. Sygnum’s Chief Investment Officer commented that the latest inflation data signals that the energy-driven inflation pressures seen in spring are gradually fading, which benefits the crypto market.
From a macro perspective, the formation of lower rate expectations theoretically favors capital flowing back into crypto assets like Bitcoin and Ethereum. However, the strength of this transmission chain depends on whether subsequent inflation data continues to validate the easing narrative.
Risk Variables Not to Overlook
Is the bond market’s repricing too optimistic? At least three risk factors warrant caution.
Risk One: Volatility in energy prices. The biggest contributor to June’s CPI cooling was the drop in energy prices, but this trend is facing challenges. As US-Iran tensions continue to escalate, the situation in the Strait of Hormuz has grown tense again. As of July 15, Brent crude has rebounded to near $85 per barrel. If geopolitical risks push oil prices above $90 or even $100, energy inflation could quickly bounce back, forcing the market to revise its expectations for Fed easing.
Risk Two: AI investment-driven demand effects. Walsh highlighted in his Congressional testimony that the US economy will "derive incalculable benefits from AI investment." TSMC’s AI chip demand continues to grow, HBM supply remains tight, and semiconductor investment is expanding—all of which could keep demand and prices elevated in related sectors. If AI capital spending drives sustained demand, "AI inflation" could become a new source of price pressure.
Risk Three: Uncertainty in the Fed’s policy framework. Walsh emphasized the need for "major adjustments" to Fed policy during the hearing. He has established five working groups to comprehensively review Fed operations. This institutional uncertainty means the future policy response function could change—and that’s precisely what markets find hardest to price.
Tiffany Wilding, an economist at Pacific Investment Management Company, summed it up well: the latest inflation data "at least gives the Fed more room to wait and see." But that does not mean the door to rate hikes is closed.
Conclusion
The 2-year Treasury yield’s largest single-day drop since August is a direct response to June’s CPI data and a concentrated reflection of the market’s repricing of the Fed’s policy path. The sharp decline in short-term yields indicates that the market is lowering expectations for imminent rate hikes and beginning to price in the possibility of a policy shift.
However, this does not mean the Fed has entered a rate-cut cycle. Walsh’s hawkish remarks in Congress remind the market that a single month’s improvement is not enough to change the Fed’s vigilance on inflation. Over the coming months, the persistence of inflation data, the direction of the labor market, and the evolution of energy prices will jointly determine whether the bond market’s judgment proves correct.
For crypto assets, changing rate expectations provide a favorable macro backdrop, but the sustainability of this logic remains to be seen. Until the Fed’s policy path becomes clear, the pricing of risk assets will continue to swing between "easing expectations" and "inflation volatility."
FAQ
Q: What does the sharp drop in 2-year Treasury yields mean for the crypto market?
The 2-year Treasury yield reflects market expectations for the Fed’s short-term interest rates. Falling yields usually signal that the market sees less pressure for rate hikes or even a shift toward easing, which improves dollar liquidity and risk appetite—providing a macro tailwind for assets like Bitcoin. However, the strength of this effect depends on whether subsequent economic data continues to support easing expectations.
Q: Will the Fed raise rates in July?
According to the CME FedWatch tool after the CPI release, the probability of a July rate hike has plunged from about 50% before the data to 15.5%, with an 84.5% chance of rates staying unchanged. The market widely expects the Fed will keep the federal funds target range at 3.50% to 3.75% at the July 29 FOMC meeting.
Q: What are the specific June CPI numbers?
US CPI for June fell 0.4% month-over-month—the first decline since May 2020—and rose 3.5% year-over-year, below May’s 4.2%. Core CPI was flat month-over-month and up 2.6% year-over-year. Both figures came in below market expectations.
Q: What does a steeper yield curve signal for the economic outlook?
A widening spread between 2-year and 10-year Treasury yields (steepening curve) usually means the market expects short-term rates to fall (fading rate hike expectations) while long-term rates remain stable. This pattern can point to a "soft landing" scenario—cooling inflation without recession, giving the Fed room to cut rates. But it may also reflect ongoing concerns about long-term inflation and fiscal deficits.
Q: How does Middle East tension affect the Fed’s policy path?
Middle East tensions mainly influence inflation expectations through energy prices. The Strait of Hormuz is a critical global oil transit route, and heightened risks can push oil prices higher, driving up overall inflation. If energy prices keep climbing, the Fed may be forced to maintain a tightening stance or reconsider rate hikes—directly clashing with the easing expectations currently driven by CPI data.
