Two years into the Federal Reserve’s battle against inflation, bond investors are seeing a new risk: Consumer price growth is slowing too much.

A day ahead of the August inflation report, one gauge of expectations of consumer price index increases is showing that the inflation rate is in danger of falling below the Fed’s target. The central bank has long argued that persistently low inflation is as detrimental to the economy as elevated prices because it would force policymakers to keep borrowing costs too low for too long, reducing the Fed’s ability to fight off economic downturns.

“Market participants are sensing that the inflationary surge is now fully over, and there’s some chance here now, with the balance of risk being shifted to the employment mandate, that the Fed undershoots its inflation target,” said Tim Duy, chief US economist at SGH Macro Advisors. “You do have to take those risks fairly seriously.”

The so-called 10-year breakeven rate fell to 2.02% on Tuesday — the lowest closing level since 2021. That suggests investors see inflation averaging over the coming decade below the Fed’s 2% goal since historically CPI runs about 40 basis points above the preferred Fed target metric, the personal consumption expenditures price index.

The rate is calculated based on the difference between the yield on inflation-protected securities, or TIPS, and standard Treasuries. The falling measure is driven by the yields on the nominal bonds falling faster than the TIPS, which typically are less traded than regular bonds.

Strategists also note some technical factors are at play, including low liquidity in US inflation-linked debt and a sharp decline in oil prices. Still, they warn the breakeven rate shows concern that the central bank may have been too slow to ease policy.

Treasuries have been rallying since the end of April as signs of cooling inflation and labor market cemented expectations that the Fed next week will deliver its first rate cut since 2020. Yields on 10-year notes touched 3.64% Tuesday, the lowest since June 2023 as Brent oil dropped below $70 a barrel.

The debate now is how fast the Fed should bring down the benchmark rate — currently in a range between 5.25% and 5.5% — to safeguard the economy. Interest rate swaps showed that traders have fully priced in a 25-basis-point Fed cut at the Sept. 18 meeting and see 20% of a chance for a jumbo half-point reduction.