Market expects inflation to slow, with the Fed expected to cut rates twice, pushing Treasury yields to this year's lows

Summary

Following a lower-than-expected January CPI report, market expectations for Federal Reserve rate cuts have solidified, with investors now betting on at least two cuts in 2026 and a rising probability of a third.MSN+ 4 The U.S. headline CPI rose 2.4% year-over-year, below the 2.5% forecast, while the core CPI met expectations at 2.5%.Reuters+ 2 This has driven U.S. Treasury yields to their lowest levels of the year, as the market prices in a more dovish Fed stance.MSN+ 2 Analysts at firms like Jefferies and Goldman Sachs had already been forecasting two cuts, with some noting the potential for three if the economy slows as predicted.Sina Finance+ 2

Impact Analysis

So the market is basically running with this one soft CPI print, taking it as a green light for multiple Fed cuts.Reuters+ 2 They’ve quickly gone from a solid consensus of two cuts to now pricing in a real chance of a third, which has crushed yields to new yearly lows.MSN+ 2 But this feels like the market getting way ahead of the Fed. Everyone is ignoring that services inflation was still hot in the report and the labor market remains stable.Zhitong The Fed has plenty of cover to remain patient.

This dovish euphoria has everyone piled into the same long-duration trade. Bottom line: the rally looks overextended and vulnerable. The pain trade is a reversal higher in yields if the next data point doesn’t cooperate or a Fed governor reminds the market they aren’t in a rush. This is a better spot to fade the bond rally than to chase it.