Wall Street rewrites interest rate script after CPI report, now expects the Federal Reserve to cut rates "2.5 times" this year

After the January inflation data was released in the United States, traders increased their bets, believing that the Federal Reserve is likely to cut interest rates more than twice by 2026. This expectation drove U.S. Treasury prices higher.

The U.S. Bureau of Labor Statistics released a report on Friday (February 13) before the stock market opened, showing that the January Consumer Price Index (CPI) increased by 2.4% year-over-year, below the market forecast of 2.5%, and down 0.3 percentage points from December 2025’s 2.7%, hitting a new low since June last year.

Analysts believe this data may ease some Federal Reserve officials’ concerns, as most policymakers previously thought U.S. inflation remained too high to justify further rate cuts when signs of a softening labor market appeared.

Tim Musial, Head of Fixed Income at CIBC Private Wealth Group, said, “The labor market still dominates the Fed’s policy direction, but they are eager for inflation to continue cooling. This CPI report is a positive sign in that regard.”

Currently, traders expect a total rate cut of about 63 basis points by the end of the year, higher than the 58 basis points anticipated on Thursday. The expectation of 63 basis points implies that the Fed’s rate cuts (each 25 basis points) will be roughly in the middle of two and three cuts within the year.

In terms of timing, traders have fully priced in the possibility of rate cuts starting before the July meeting and also see a high probability of action in June. Previously, Wall Street banks that forecast a rate cut in March have delayed their expectations after the employment data was released.

Another noteworthy event this week was the historic strong demand for the newly issued 30-year U.S. Treasury bonds, indicating that investors believe yields will not rise again despite geopolitical tensions and a large fiscal deficit weakening the dollar.

Jonathan Cohn, Head of U.S. Interest Rate Strategy at Nomura Securities International, said that the positive reaction to inflation data is limited by the continued improvement outlook of the labor market, as this reduces the need for the Fed to cut rates further.

“This again shows that the Fed remains more sensitive to the employment policy goal,” Cohn added. “I think what we saw this week in the financial markets was more a re-pricing (sell-off) driven by weakening risk sentiment rather than the economic data itself.”

(Source: Caixin)