Is the Federal Reserve just one step away from cutting interest rates next week? Bond traders are closely watching CPI and PPI data

U.S. bond traders hope to navigate a turbulent year smoothly—unless inflation unexpectedly surges, putting them in a bind again.

According to Zhitong Finance APP, U.S. Treasury bonds continued their recent rebound last Friday, following a monthly employment report that indicated the job market is cooling enough to allow the Federal Reserve to cut rates again at the conclusion of its meeting on December 18. Employment data is viewed as one of the last key indicators before the rate-setting meeting, and this week’s Consumer Price Index (CPI) and Producer Price Index (PPI) are expected to show a slight increase in inflationary pressures.

The managing partner of Winshore Capital Partners stated, “Unless the CPI unexpectedly rises significantly, the Fed's benchmark is to cut rates this month, as they feel their policy is still restrictive. Therefore, I believe U.S. Treasury yields have peaked.”

This widespread belief has temporarily relieved investors from the sell-off in the U.S. Treasury market. The bond market sell-off peaked in November when Donald Trump won the U.S. election, increasing the risk that his tariffs and tax cuts could reignite inflation. However, since then, yields have retreated as the market speculates that the Fed will ease policy again at this month’s meeting, which is the last meeting before Trump takes office, as the Fed attempts to guide the economy to a soft landing.

The benchmark 10-year U.S. Treasury yield has fallen to around 4.15% since hitting a post-election high of 4.5% on November 15. The Bloomberg index shows that U.S. Treasuries have risen 2.4% this year as of December 5.

However, this period of calm may be relatively short-lived due to significant uncertainties in the outlook. This largely stems from doubts about policy shifts during Trump's presidency, as his tax cuts are expected to stimulate an already strong economy, and the increased deficit may accelerate bond issuance. His tariff plans are another source of uncertainty—potentially pushing up import prices and dragging down global trade, depending on the specifics of the tariff plans.

As traders and Fed policymakers take a wait-and-see approach, these issues may limit the upside in the bond market. Swap pricing indicates that the Fed may delay rate cuts at its January meeting next year.

Tracy Chen, a portfolio manager at Brandywine Global Investment Management, stated, “The U.S. economy is very resilient. The Fed may be closer to pausing rate cuts, expecting to pause at some point early next year to adjust based on Trump’s policies and upcoming data.”

The employment data released last Friday supported the view that the restrictive policies still being implemented by the Fed are cooling the economy. Although November's hiring rebounded from the slowdown in the previous month (partly due to hurricanes), the unemployment rate unexpectedly rose.

This data is seen as potentially providing room for Fed officials to ease policy again this month, unless this week’s reports show inflation accelerating unexpectedly.

Market forecasts indicate that U.S. core consumer prices—considered the best indicator of potential inflationary pressures—rose 0.3% in November, the same increase as the previous month. As this data is released, Fed officials are in a quiet period ahead of the rate-setting meeting Amar Reganti, fixed income strategist at Hartford Funds, stated, "All signs indicate that there will be a rate cut in December, but inflation remains a significant issue, so there is a slight tail risk surrounding the release of CPI data."

He added, "However, considering that U.S. Treasury yields have already declined since November, it is difficult to see yields drop further unless we really start to see a significant decrease in inflation. This is especially true given the many unknown factors regarding U.S. government and congressional policies next year."