Markets on inflation watch

US Treasury yields jumped and the dollar strengthened to the highest level in almost five months ahead of key inflation data that could further shape market expectations on the pace of the Federal Reserve’s interest rate cuts. The yield on the 10-year Treasury rose 12 basis points to 4.43% on Tuesday, bringing its climb since mid-September to 81 basis points and marking the highest close since July.

Inflation concerns have resurfaced in recent months, as the latest economic data point to a stronger economy than previously thought. The potential impact of President-elect Donald Trump’s likely policies on tax, tariffs, and fiscal spending is also contributing to a repricing of the Fed’s policy ahead. Fed funds futures now indicate an almost 70% chance that the US central bank will cut rates by less than 50 basis points between now and June 2025, compared to a 63% likelihood just a week ago that rates would be reduced by 75 basis points or more.

October’s consumer price index (CPI) and producer price index (PPI)—due today and Thursday, respectively—will give markets additional information to assess the Fed’s next moves, but we think the direction of travel is more important for investors, especially those with elevated cash balances.

Price pressure should continue to moderate in the coming months. The consensus forecast is for the headline CPI to remain at 2.4% year over year in October, with the core rate holding steady at 3.3%. While shelter has taken longer to slow than we expected, it does appear that the data finally turned last month. If this more moderate pace of increase is maintained, it would help to keep inflation on a downward trend in the months ahead. Separately, the Fed’s preferred gauge of inflation, the personal consumption expenditures (PCE) price index, fell to 2.1% in September—the lowest level in three years. Overall, we expect the broad disinflation trend to continue, allowing the Fed to continue easing.

Fed policy remains in restrictive territory. Comments from Fed officials in recent days showed that policymakers still view the current interest rate as restrictive. Richmond Fed President Thomas Barkin called the current level of rates “somewhat less restrictive” than it had been, and noted that risks to the central bank’s employment and inflation goals are roughly in balance. Minneapolis Fed President Neel Kashkari said the current policy is “still in a modestly contractionary stance,” and that the economy will guide the Fed “in terms of how far we need to go” in cutting rates. Asked what could prompt the Fed to pause rate cuts at the December meeting, Kashkari added that “there’d have to be a surprise on the inflation front to change the outlook so dramatically.” We continue to believe that the current US economic condition does not warrant an actively restrictive monetary policy.

The Fed’s last meeting indicates more cuts are in store. Fed Chair Jerome Powell refused to provide guidance on the possibility of a December cut at the Federal Open Market Committee (FOMC) meeting last week, but he noted that the US central bank remains on a path to bring policy closer to neutral. To us, the committee’s desire to not see any more labor market cooling and Powell’s explicit comment that the central bank does not speculate on future fiscal policy indicate more cuts are likely to come. Recent data suggest a softening labor market, with job openings in September falling to the lowest level since January 2021 and wages growing at the slowest pace since the second quarter of 2021.

So, barring any surprises in upcoming data, we expect another 25 basis points of Fed rate cuts in December and further easing in 2025. Investors should shift excess cash into quality fixed income or consider diversified fixed income strategies as a way to enhance portfolio income. We also see US equities as Attractive amid solid economic growth, Fed easing, and robust AI investment.