In the blink of an eye on Tuesday, the U.S. bond market’s focus shifted back toward fears of an unexpectedly sharp economic slowdown and away for now from persistently high inflation.

That sentiment shift occurred after data showed U.S. new home sales plunged in July to the lowest level in more than six years. Gauges of the manufacturing and service sectors also came in below expectations, reinforcing similar weakness seen in the eurozone. On Tuesday, traders priced in a better-than-not chance of a 50-basis-point interest rate hike by Federal Reserve policy makers in September, which would lift the fed funds rate target to between 2.75% and 3%, pulling back from Monday’s expectations for a bigger 75-basis-point hike next month.

Financial markets have been caught between two narratives — one of troublingly elevated inflation that forces policy makers to keep aggressively raising borrowing costs, the other of an economic slowdown that resolves the inflation problem and prompts the Fed to pivot. Both of these narratives could add up anyway to something that looks and feels like the worst of all worlds: stagflation.

“The data is weakening and the market is considering a Fed pivot” in the form of a half-point hike in September, said trader Tom di Galoma of Seaport Global Holdings in Greenwich, Connecticut. “I don’t see a pivot, but the market is starting to see one.”

“We’re starting to go into a real slowdown in the housing market, which overall is not good for the economy just because that market fuels so much of the expenditures that were taking place,” he said via phone om Tuesday. “But my impression is that the Fed will want to get rates as high as it can before a full slowdown takes place around October. The Fed was going to hike into a slowing economy anyway, but when the numbers become real, people get nervous.”

On Tuesday, U.S. yields fell across the board after the disappointing report on July’s new-home sales, led by the 2-year
TMUBMUSD02Y,
3.293%,
which captures the expected path of the Fed’s rate policy. The 10-year yield
TMUBMUSD10Y,
3.038%
dropped below 3% during morning trading, while its spread to the 2-year narrowed to minus 26 basis points in a still-worrisome sign of the outlook ahead of Friday’s speech by Fed Chairman Jerome Powell at the central bank’s symposium in Jackson Hole, Wyo.

U.S. stocks struggled to regain their footing through afternoon trading, a day after posting their worst day since June on fears that the Fed would move forward with sharply higher interest rates. The Dow industrials DJIA were down 95 points, or 0.3%, in afternoon trading, while the S&P 500 SPX was little changed and the Nasdaq Composite COMP was higher by 0.3%. Meanwhile, the ICE U.S. Dollar Index DXY was down 0.5%, retracing most of Monday’s advance.

“Softer U.S. data took the edge off Jackson Hole panic this morning, yet markets still prep for a worst case outcome this Friday,” said Jim Vogel, executive vice president at FHN Financial in Memphis. “Just don’t ask anyone to articulate what that worst case might look like. It simply could be bad.”

“The Fed has moved into a data dependent phase — increasing chances Chair Powell hedges even the most hawkish message by a smidge,” Vogel wrote in a note.

For Jay Hatfield, chief investment officer of Infrastructure Capital Advisors in New York, which oversees around $1.18 billion in assets, the “real story” behind Tuesday’s bond-market moves is that “U.S. bonds outperformed the rest of the world.”

The reason that the U.S. bond market had sold off on Friday was because the global bond market “was cracking,” according to Hatfield. Germany printed a 5.3% month-over-month gain in producer prices and an “unimaginable” year-over-year gain of more than 30%, while natural-gas prices in some parts of Europe have hit the energy equivalent of $500 a barrel, stoking fears that the European Central Bank will be “more aggressive.”

But as of Tuesday, a 3% level on the U.S.10-year yield was finding interest from both buyers and sellers, and staying “pretty well-anchored,” Hatfield said via phone, adding that he expects the Fed to lift rates by 50 basis points in September.

“You can’t look at U.S. rates in a vacuum and U.S. bonds are by far the most attractive in the world,” he said. Meanwhile, a short-term Treasury yield trading above longer-term rates is “pricing in stagflation.”