Bond Market Wrap: Yields Rise as Market Braces for CPI Report

The U.S. Treasury market saw a broad decline on Tuesday, pushing yields to one-week highs as investors positioned themselves ahead of the highly anticipated January Consumer Price Index (CPI) report.

The Federal Reserve’s patient stance on rate cuts, combined with new trade tariffs on aluminum and steel, added to uncertainty in fixed-income markets.

While Fed Chair Jerome Powell’s testimony before Congress reiterated the central bank's cautious approach to monetary easing, it failed to offer any new policy insights, leaving bond traders focused on inflation trends and evolving trade policy dynamics.

Key Drivers of Treasury Market Decline

1. CPI Report Looms Over Fixed-Income Markets

Investors remained cautious as they awaited the release of January’s CPI data on Wednesday morning. The consensus forecast calls for:

- Headline CPI to increase by 0.3% month-over-month (prior: 0.4%)

- Core CPI (which excludes food and energy) to rise by 0.3% month-over-month (prior: 0.2%)

Markets are particularly sensitive to this inflation data, as a hotter-than-expected reading could push back rate-cut expectations further into the year. Currently, futures pricing suggests a first Fed rate cut is unlikely before June, a shift from earlier expectations of a March move.

2. Fed Chair Powell Stays Cautious, Yields Edge Higher

Powell's testimony before the Senate Banking Committee reinforced the central bank’s wait-and-see approach to monetary policy. He did not indicate any urgency to cut rates, emphasizing:

- Inflation risks remain tilted to the upside, making it prudent to hold rates steady for now.

- The economy remains strong, and job growth is resilient, reducing the need for immediate easing.

- Any Fed moves will be data-dependent, with a particular focus on upcoming inflation readings.

Following Powell’s remarks, Treasury yields moved higher across the curve, with the 10-year yield rising to 4.54% and the 2-year yield climbing to 4.29%. The bond market’s reaction suggests that investors expect the Fed to maintain its cautious stance in the near term.

3. Trade Tariffs Add to Market Uncertainty

The White House confirmed that new 25% tariffs on steel and aluminum imports will take effect on March 12, escalating trade tensions and raising concerns about higher input costs for U.S. manufacturers.

- Australia may receive an exemption, but other major exporters—including Canada, Mexico, and the European Union—are likely to retaliate.

- Germany’s steel industry expressed concerns that excess global steel production may now shift to Europe, creating oversupply and pressuring prices.

- Mexico's economy minister called the tariffs a "bad idea" and vowed to consult with the U.S. on potential alternatives.

While higher tariffs could increase inflationary pressures, their impact on monetary policy is still unclear. If companies pass costs to consumers, the Fed may delay rate cuts further to prevent a re-acceleration in price pressures.

Yield Movements and Auction Demand

Treasury yields rose across all maturities, reflecting the market’s defensive positioning ahead of inflation data and trade uncertainties.

Yield Check:

- 2-year yield: +2 basis points (bps) to 4.29%

- 3-year yield: +2 bps to 4.31%

- 5-year yield: +4 bps to 4.37%

- 10-year yield: +4 bps to 4.54%

- 30-year yield: +4 bps to 4.75%

In the Treasury auction space, the $58 billion 3-year note auction received strong demand, breaking a streak of five consecutive weak auctions in this tenor.

- The auction stopped through by more than a basis point, meaning that buyers were willing to accept a slightly lower yield than market expectations.

- The bid-to-cover ratio of 2.79 was well above the 12-auction average of 2.57, suggesting healthy investor interest in shorter-dated Treasuries.

- Indirect bidders (foreign central banks and institutions) took a hefty 74% of the issuance, far above the historical norm of 65.4%, indicating strong international demand for U.S. debt.

However, longer-dated Treasuries struggled, with yields on 10-year and 30-year notes climbing as traders sought clarity on Fed policy and inflation trends.

Global Market Developments and Economic Data

Beyond the U.S., several global economic indicators and central bank comments added to investor sentiment:

- Australia’s Prime Minister Albanese stated that President Trump is considering a tariff exemption for Australian steel imports.

- South Korea’s exports rose 0.8% year-over-year in early February, signaling gradual recovery in global trade.

- French Prime Minister Bayrou survived another no-confidence vote, ensuring political stability in the eurozone’s second-largest economy.

- The Bank of England’s Catherine Mann stated that corporate pricing power is weakening, suggesting that inflationary pressures in the UK may be easing.

On the domestic front, the NFIB Small Business Optimism Index fell to 102.8 in January from 105.1 in December, reflecting growing concerns among small business owners about rising costs and policy uncertainty.

Market Outlook: What’s Next for Treasuries and Inflation Expectations?

Heading into Wednesday’s CPI report, the bond market remains on edge, with several key factors in play:

1. A Hot CPI Print Could Push Yields Even Higher

- If inflation comes in above expectations (above 0.3% month-over-month for both headline and core CPI), yields could surge further, pushing back Fed rate-cut expectations.

2. Fed Policy Remains in Focus

- Powell will continue his congressional testimony, where he may offer further insights into the Fed’s thinking on inflation risks and rate cuts.

3. Tariff Fallout Could Impact Rate Expectations

- If retaliatory tariffs from trading partners drive up consumer prices, markets may adjust rate-cut expectations even further, reducing the likelihood of easing in mid-2025.

4. Treasury Auctions Will Be a Key Sentiment Indicator

- The $42 billion 10-year Treasury auction on Wednesday afternoon will be a crucial test of demand for longer-dated bonds.

- A weak auction result (low bid-to-cover ratio or high tailing yield) could trigger a further sell-off in bonds, pushing yields higher.

Final Thoughts: Defensive Positioning Ahead of CPI Data

The bond market remains in defensive mode, with traders positioning for potential upside surprises in inflation data while navigating new tariff risks.

If CPI remains elevated, expect:

- More hawkish Fed rhetoric, pushing rate-cut expectations further into late 2025.

- Higher Treasury yields, particularly on the 10-year and 30-year bonds.

- Continued market volatility, as investors adjust to a more uncertain rate environment.

Conversely, if CPI comes in lower than expected, the bond market could rally, as expectations for Fed rate cuts move forward again.

With rate policy, trade tensions, and economic data all converging, the next few trading sessions could prove pivotal in shaping fixed-income and equity market direction for the months ahead.