Tuesday’s U.S. Jan CPI report was stronger than expected and dashed hopes for imminent interest rate cuts from the Fed. Jan CPI eased to +3.1% y/y from +3.4% y/y in Dec, stronger than expectations of +2.9% y/y. Also, Jan core CPI (ex-food and energy) of +3.9% y/y was unchanged from December’s 2-1/2 year low and was stronger than expectations of +3.7% y/y. The report pushed the 10-year T-note yield up to a 2-1/2 month high of 4.330% and pushed back Fed rate cut expectations.
The 10-year T-note yield has risen sharply from December’s 6-1/2 month low of 3.782%, which was posted on market hopes for relatively quick Fed rate cuts. Recent comments from Fed Chair Powell, however, threw cold water on rate-cut expectations when he argued against against market bets that the Fed would start cutting rates as soon as the March 19-20 FOMC meeting. The surge in T-note yields continued Tuesday after the hot CPI report pushed back bets on the timing of the first Fed interest rate cut.
Swap markets now discount the chances for a -25 bp rate cut at 11% for the March 19-20 FOMC, well below the 70% chance the markets priced in last month. The market has pushed back the chances for the first Fed cut to the June 11-12 FOMC meeting. TD Securities said, “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.”
The markets are now fully pricing in only three Fed rate cuts for this year, and a 70% chance for a fourth rate cut. That is aligned with the Fed’s own forecast for three rate cuts and is well below the market’s outlook a month ago when swaps showed the potential for as many as seven -25 bp cuts in the federal funds target rate. Pendal Group said the strength of the U.S. economy makes Treasuries unattractive at the moment, despite the fact that rate bets are now better aligned with Fed guidance.
Fed policymakers favor an inflation measure known as the personal consumption expenditure price index (PCE), which is tabulated differently than the consumer price index. The Dec core PCE fell to 2.9% y/y from 3.2% y/y in Nov, the smallest increase in 2-3/4 years and closer to the Fed’s 2.0% inflation target. However, the strength of Tuesday’s CPI report may also push the Jan core PCE higher when it is released on February 29. Morgan Stanley said, “This acceleration will be one factor delaying the decision by the Fed to start cutting rates to June this year.”
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On the date of publication, Rich Asplund did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
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