The release of the U.S. Jan CPI report on Tuesday delivered stronger-than-anticipated figures, dimming prospects for imminent interest rate cuts by the Federal Reserve. January’s CPI eased to +3.1% year-over-year from December’s +3.4%, surpassing expectations of +2.9%. Moreover, January’s core CPI, excluding food and energy, held steady at +3.9% year-over-year, matching December’s 2-1/2 year low and surpassing expectations of +3.7%.
The report triggered an upsurge in the 10-year Treasury note yield to a 2-1/2 month high of 4.330% and consequently pushed back expectations for Fed rate cuts. The yield on the 10-year Treasury note has notably risen from December’s low of 3.782%, fueled by market hopes for swift Fed rate cuts. However, recent statements from Fed Chair Powell dampened expectations of imminent rate cuts, countering market predictions of cuts as early as the March 19-20 FOMC meeting. Tuesday’s CPI report further delayed bets on the timing of the first Fed interest rate cut.
According to swap markets, the probability of a -25 basis point rate cut at the March 19-20 FOMC meeting now stands at 11%, a significant drop from the 70% chance priced in last month. The market has shifted expectations for the first rate cut to the June 11-12 FOMC meeting. TD Securities noted, “The January CPI is a game changer, and there is now a real risk that price pressures will begin to shift higher. This should provide momentum for further bond declines.”
Currently, the markets fully price in three Fed rate cuts for the year, with a 70% likelihood of a fourth rate cut. This aligns with the Fed’s own forecast for three rate cuts and contrasts sharply with the market’s outlook a month ago, which suggested the potential for as many as seven -25 basis point cuts in the federal funds target rate. Despite better alignment with Fed guidance, Pendal Group emphasized that the strength of the U.S. economy makes Treasuries unattractive at present.
Fed policymakers predominantly favor the personal consumption expenditure price index (PCE) as an inflation measure, which differs from the consumer price index. Although the December core PCE dipped to 2.9% year-over-year from 3.2% in November, the smallest increase in 2-3/4 years, and closer to the Fed’s 2.0% inflation target, the robustness of Tuesday’s CPI report could push the January core PCE higher upon its release on February 29. Morgan Stanley highlighted, “This acceleration will be one factor delaying the decision by the Fed to start cutting rates to June this year.”
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