• US short-term interest-rate futures rose on Thursday after a key inflation report came in cooler than expected, leading traders to scale back bets on further Federal Reserve rate hikes.
  • The shift in market pricing suggests a growing belief that the central bank may be done tightening, though rate cuts remain distant.
  • Economists caution that inflation remains above target, and the path for policy remains data-dependent.

Traders Rethink Rate Path

US short-term interest-rate futures climbed on Thursday following the release of the latest consumer price index, which showed core inflation rising 0.2% month-over-month, below the 0.3% consensus estimate. The annual rate eased to 3.6% from 3.8%, reinforcing expectations that the Fed will hold rates steady at its upcoming meeting.

According to CME Group data, fed funds futures now imply a 65% probability that the central bank will keep rates unchanged in June, up from 60% a day earlier. Futures also priced in a lower terminal rate, with the implied peak dropping to around 5.08% from 5.14% before the release.

"The market is breathing a sigh of relief," said a trader at a major bank, who asked not to be identified discussing private views. "This print reduces the urgency for a hike, but we're not out of the woods yet."

The rally in futures was accompanied by a modest downturn in the dollar and a lift in Treasuries, with the two-year yield falling 6 basis points to 4.87%.

Sticky Inflation Still a Concern

Despite the softer-than-expected data, some economists warned that inflation remains stickier than the Fed would like, particularly in services. "One month doesn't make a trend," said Sarah Johnson, chief US economist at a research firm. "The Fed needs to see a sustained slowdown before it can declare victory."

The personal consumption expenditures price index, the Fed's preferred gauge, remains above the 2% target, complicating the outlook for rate cuts. Traders are now pricing in a first rate cut in September, though the odds remain below 50%.

Broader Implications

The shift in rate expectations is rippling through global markets, with the euro strengthening against the dollar and emerging-market currencies gaining. Higher-for-longer US rates had been a headwind for risk assets, and any easing of that pressure could provide a tailwind for equities and commodities.

For households, the prospect of a peak in rates offers some relief for mortgage and auto loan borrowers, though borrowing costs are likely to remain elevated for the foreseeable future.

The Fed has emphasized that its decisions will remain data-dependent, and market participants are now focused on upcoming employment and inflation readings. Any upside surprise could quickly reverse the recent dovish repricing.

Correction: An earlier version of this article incorrectly stated the year-over-year core PCE rate. The correct figure is 2.8%, not 3.6%. The error has been corrected.