Bond Market Sees Inflation as a Wild Card for Easing Timetable at Fed Meeting

• While bond investors expect the U.S. Federal Reserve to keep rates unchanged at its policy announcement this Wednesday, the market reaction could hinge on what Fed officials indicate about stubborn inflation and if their signals get more hawkish about the timing and extent of any easing this year.
• Stronger-than-expected economic growth and stickier inflation this year have led investors to push back expectations on the U.S. central bank's first rate cut to June, from May, and reduce bets on how many cuts are likely this year. Traders are now pricing in three 25-basis-point cuts, in line with Fed policymakers' median expectations in December.
• Benchmark 10-year Treasury yields rose to a one-month high of 4.328% on Monday and jumped from 4.052% a week ago as traders adjusted for a more hawkish Fed. In December, the Fed pivoted to a more dovish outlook on growing confidence that inflation was on track to its 2% annual target. Inflation has since picked up, though analysts note that recent hotter-than-expected consumer and producer price index reports likely reflected seasonal factors.
• After the Fed's January meeting, Powell said that the central bank wants more confidence that inflation will continue to decline before cutting rates. "The Fed doesn't want to break anything," said Padhraic Garvey, regional head of research Americas at ING. He added that when inflation gets closer to 2%, the Fed will likely "use that opportunity to get rates off the highs."
• In the meantime, the Fed may be cautious about the prospect of near-term rate cuts. "The main focus is which way they lean," said Stephen Gola, head of U.S. Treasuries Sales & Trading at StoneX Group. An unexpected uptick in unemployment last month could keep the Fed circumspect on growth, offsetting some inflation concerns.
• Another possibility is that Powell could adopt a more hawkish tone by referencing loose financial conditions as stock markets hit records and corporate credit draws enthusiastic demand.

(Source: Reuters)