Bond Market Wrap: Yields Surge as Hot CPI Pushes Rate Cut Expectations Further Out

The U.S. Treasury market faced sharp losses on Wednesday following the release of a hotter-than-expected Consumer Price Index (CPI) report, forcing a shift in rate-cut expectations and sending yields to new monthly highs. Investors had been closely watching the inflation data for signs that the Federal Reserve might soon begin easing its restrictive monetary policy, but the data suggested otherwise.

The CPI report showed that inflation remains sticky, with total CPI rising 0.5 percent month-over-month, surpassing the consensus estimate of 0.3 percent. Core CPI, which excludes volatile food and energy prices, also came in above expectations at 0.4 percent for January, up from 0.2 percent in December. On a year-over-year basis, total CPI increased to 3.0 percent from 2.9 percent, while core CPI rose to 3.3 percent from 3.2 percent.

This unwelcome inflationary trend led to a major recalibration of interest rate expectations. Before the report, traders had been pricing in a potential rate cut as early as July. Now, those expectations have been pushed back to September, with some analysts even speculating that the Federal Reserve could be forced to keep rates higher for longer or, in an extreme scenario, consider tightening again if inflation does not cool further.

The immediate market reaction was a broad selloff in Treasuries, which sent yields sharply higher across the curve. The benchmark 10-year Treasury yield jumped 10 basis points to 4.64 percent, while the 2-year yield, which is more sensitive to Fed policy, surged 8 basis points to 4.37 percent. The 30-year yield rose to 4.84 percent, reflecting growing uncertainty about the long-term inflation trajectory.

Federal Reserve Chairman Jerome Powell, who was on Capitol Hill for the second day of his semiannual testimony, addressed the inflation data but downplayed the significance of a single monthly report. He reiterated that the central bank primarily relies on the Personal Consumption Expenditures (PCE) Price Index when evaluating inflation trends. However, Powell’s comments did little to ease concerns, as the Treasury market remained under pressure throughout the day.

Further weighing on Treasuries was a disappointing $42 billion 10-year note auction. The high yield of 4.632 percent came in above the 12-auction average of 4.243 percent, signaling weak demand. The bid-to-cover ratio, which measures demand relative to the supply of bonds, stood at 2.48, slightly below the recent average of 2.54. Indirect bidders, a category that includes foreign central banks, accounted for 71.5 percent of the auction, compared to the recent average of 67.2 percent.

The inflation data and its impact on monetary policy were not the only major developments in global markets. In geopolitical news, President Trump spoke with Russian President Vladimir Putin about starting negotiations to end the war in Ukraine.

Trump later spoke with Ukrainian President Volodymyr Zelensky and announced plans to send Vice President J.D. Vance and Secretary of State Marco Rubio to Munich for peace negotiations set to begin on Friday. While details remain scarce, the announcement suggests that diplomatic efforts to resolve the ongoing conflict could be gaining momentum.

International economic reports were mixed. In Asia, China announced new restrictions on copper smelters in an effort to address overcapacity. Meanwhile, India’s inflation data showed signs of easing, with CPI falling to 4.31 percent in January, below the expected 4.60 percent and down from 5.22 percent in December. However, Italy’s industrial production disappointed, dropping 3.1 percent month-over-month in December, far below the expected decline of 0.1 percent.

In commodities, crude oil prices fell sharply, dropping 2.7 percent to $71.37 per barrel, as concerns over weaker demand weighed on the market. Gold declined 0.2 percent to $2,928.10 per ounce, while copper prices rose 2.2 percent to $4.70 per pound, reflecting optimism about China’s latest policy measures to support the metal market.

The foreign exchange market saw notable moves as well. The U.S. dollar remained steady, with the Dollar Index holding at 107.95. The euro gained 0.3 percent against the dollar to trade at 1.0388, while the British pound was unchanged at 1.2442. The Japanese yen weakened sharply, with USD/JPY climbing 1.3 percent to 154.45, reflecting diverging monetary policies between the Federal Reserve and the Bank of Japan.

Looking ahead, investors will be closely watching upcoming economic data, including the Producer Price Index (PPI) and weekly jobless claims. The PPI report will provide further insight into inflationary pressures at the wholesale level, while jobless claims will offer clues about the strength of the labor market. Additionally, the Treasury will hold a $25 billion auction for 30-year bonds, which will be closely monitored for signs of demand strength in longer-duration government debt.

The latest developments reinforce the challenges facing markets as inflation remains persistent and the Federal Reserve's path forward remains uncertain. While equity markets have been resilient in the face of shifting rate expectations, the bond market’s reaction underscores the heightened sensitivity to inflation data. Investors will need to remain nimble as they navigate a landscape where policy uncertainty and economic fundamentals remain in flux.