The Inflation Split: Why Intermediate-Treasury Bonds Offer a Safe Yield Boost

The latest Producer Price Index (PPI) data for June 2025 reveals a critical cooling in wholesale inflation, with the headline PPI flat at 0.0% month-over-month and the annual rate dipping to 2.3%—the lowest since September 遑2024. This contrasts sharply with the sticky core Consumer Price Index (CPI), which rose to 2.9% year-over-year, highlighting a divergence that could reshape Federal Reserve policy and bond market dynamics. For fixed-income investors, this split creates a tactical opportunity in 5-7 year Treasury bonds, where yields remain attractive while risks of further rate hikes fade.

The PPI-CPI Divergence: A Fed Policy Crossroads

The PPI's cooldown signals easing producer-level inflation pressures, driven by falling energy inputs (natural gas down 5.9% annually) and collapsing agricultural prices (ungraded chicken eggs plummeted 25% in June). Meanwhile, CPI remains elevated due to persistent services inflation (e.g., housing at 3.8% annually) and the delayed impact of tariffs on consumer goods. This disconnect weakens the Fed's case for further rate hikes:

The current spread of 0.53% reflects market pricing of a pause in rate increases. With the Fed's terminal rate likely capped at 5.50%, the risk of aggressive policy shifts diminishes, favoring bonds. Intermediate-term Treasuries (5-7 years) now offer a yield pickup of 0.2-0.3% over short-term bills while avoiding the duration risk of long-dated bonds, which face heightened volatility if the Fed's stance shifts abruptly.

Why 5-7 Year Treasuries Are the Sweet Spot

1. Yield Advantage: The 5-year Treasury yields 4.35%, while the 7-year offers 4.11%—both above their long-term averages and far superior to cash.
2. Risk-Adjusted Safety: Intermediate maturities have lower sensitivity to rate hikes than 10+ year bonds. For example, a 1% rate rise would reduce a 5-year bond's price by ~3%, versus ~7% for a 10-year.
3. Curve Flattening: As the Fed pauses, the yield curve will likely flatten further. Investors gain from the roll-down effect, where bonds move toward maturity and appreciation as yields compress.

Risks to Monitor

• Fed Communication: If policymakers emphasize “data dependency” and hint at more hikes, yields could spike.
• Tariff Escalation: A sudden surge in goods prices (e.g., due to new trade restrictions) could force CPI higher, reigniting rate hike fears.

Investment Play: Buy the Dip in Intermediate Treasuries

The PPI-CPI split suggests the Fed's pause is here to stay, making intermediate Treasuries a high-conviction trade. Investors should:
- Allocate 5-10% of fixed-income portfolios to 5-7 year Treasuries via ETFs like IEF (7-10 years) or SCHZ (5-10 years).
- Avoid Overextension: Limit exposure to 10+ year bonds until the yield curve inverts or CPI definitively cools.

Conclusion

The cooling PPI and sticky CPI create a unique inflection point. While the Fed's caution is clear, bond traders may overreact to short-term volatility, offering a buying opportunity in intermediate Treasuries. With yields attractive and risks manageable, this segment of the bond market is primed to deliver steady returns without excessive duration exposure.

Act now: The window to lock in these yields may narrow as the Fed's pause solidifies.