Bond yields remained relatively stable on Tuesday as traders held back ahead of the release of a crucial U.S. consumer price inflation report. The report, which provides data on the January consumer price index, will be published by the Bureau of Labor Statistics at 8:30 a.m. Eastern Time.

Forecasted Inflation Rates

The headline annual Consumer Price Index (CPI) inflation rate is expected to have decreased from 3.4% in December to 2.9% in January, the lowest level since March 2021. Meanwhile, the core annual rate, which excludes volatile components like food and energy, is predicted to drop from 3.9% to 3.7%.

On a month-on-month basis, the headline rate is anticipated to decline from 0.3% in December to 0.2% in January, while the core rate is projected to remain at 0.3%.

Implications for Financial Markets

According to Stephen Stanley, chief U.S. economist at Santander, the upcoming data will likely shape the trajectory of financial markets in the coming weeks, leading up to the release of the January PCE deflator on February 29th.

If the report aligns with or falls below expectations, traders may begin considering the possibility of a rate cut by the Federal Reserve in May.

Currently, market indicators suggest an 86.5% probability that the Fed will maintain interest rates within the range of 5.25% to 5.50% following its next meeting on March 20th, as reported by the CME FedWatch tool.

Chances of Rate Cut and Fed Funds Rate Target

The probability of a 25 basis point rate cut by the next meeting in May is estimated at 54.7%. According to 30-day Fed Funds futures, the central bank is anticipated to lower its Fed funds rate target to approximately 4.31% by December 2024.

Inflationary Pressures in the U.K.

The U.K. serves as a reminder that inflationary pressures can persist. The Office for National Statistics in Britain reported that average weekly wages, including bonuses, increased by 5.8% in the year ending December, surpassing expectations of 5.6%.

The rise in earnings inflation corresponds with a tightening labor market in the U.K., as the unemployment rate dropped from a revised 4.2% in November to 3.8% in December. Consequently, the pound GBPUSD, +0.21% experienced an upward trajectory and the U.K. 2-year government bond yield climbed 3.3 basis points to 4.091%.

Fed Officials' Remarks and Outlook

Deutsche Bank economists, led by Amy Yang, highlight that last week, Federal Reserve officials, spanning the hawk-dove spectrum, reiterated Chair Powell's messages from the January FOMC meeting. They expressed encouragement regarding recent progress on inflation but emphasized the need for further data to gain confidence that inflation is consistently trending towards 2%.

Taking into account these comments, along with robust January payroll data and the marginal impact from the CPI seasonal factor revisions, the Deutsche Bank team aligns with their Fed view. They expect the first interest rate cut to commence in June, with a total reduction of 100 basis points to be implemented throughout the year.

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