U.S. Treasury yield alarm: Tonight's CPI may exceed expectations, Wall Street bets on two rate cuts by the Federal Reserve this year

According to the Zhitong Finance APP, the U.S. July CPI will be released at 20:30 Beijing time on Tuesday. This latest inflation data will provide clues for bond traders betting on a rate cut by the Federal Reserve in September, to understand how U.S. President Trump's tariff policy is affecting inflation.

Wall Street economists expect the U.S. July CPI to rise 2.8% year-on-year, up from 2.7% in June. The core CPI for July, excluding food and energy prices, is expected to rise 3% year-on-year, up from 2.9% in June; the July core CPI is expected to rise 0.3% month-on-month, up from 0.2% in June.

After signs of a weakening U.S. labor market emerged, market expectations for a rate cut by the Federal Reserve in September quickly heated up. Swap trading shows that investors are betting on two 25 basis point rate cuts by the Federal Reserve before the end of this year. Some investors are even betting that the Federal Reserve will make a significant 50 basis point cut in September. Driven by expectations of rate cuts, U.S. Treasury yields have fallen to levels not seen since the end of April.

The CME Group's "FedWatch" tool shows that the probability of the Federal Reserve cutting rates by 25 basis points in September has reached 86.5%, the probability of a cumulative 50 basis point cut by October is 53.6%, and the probability of a cumulative 50 basis point cut by December is 43.6%.

However, market participants hoping for a rate cut by the Federal Reserve in September may face the key obstacle of inflation. Recent reports from Bank of America, Apollo Global Management, and BNY Mellon have all listed stagflation as a major concern.

Gennadiy Goldberg, head of U.S. interest rate strategy at TD Securities, stated, "The market is looking for further evidence that changes in tariff policy are translating into rising commodity inflation. All else being equal, rising inflation may lead the Federal Reserve to want to see more data before proceeding with a rate cut."

George Catrambone, head of fixed income at DWS Americas, noted that if inflation continues to rise in July, "the Federal Reserve's dual mandate of stabilizing employment and inflation will come into conflict," and policymakers must also consider the U.S. July PPI to be released on Thursday, as well as the subsequent U.S. August CPI before the September rate decision.

Persistently high inflation and sluggish economic growth also pose risks to the dollar. The dollar has fallen nearly 8% against a basket of currencies so far this year. Gennadiy Goldberg added that in a stagflation scenario, an economic downturn will further intensify Stubborn inflation will weaken the Federal Reserve's ability to cut interest rates in the future, while also potentially pushing U.S. Treasury yields higher. Last week, U.S. Treasury yields rose after a series of weak Treasury auctions reflected a decline in investor demand ahead of the July CPI release.

After the Federal Reserve kept interest rates unchanged last month, Chairman Jerome Powell reiterated that officials need more time to assess the impact of tariffs before considering rate cuts. However, Federal Reserve governors Waller and Bowman, appointed by Trump, hold a different view and support an immediate rate cut due to a weak labor market. Additionally, Trump's nomination of his economic advisor council chairman Stephen Moore to replace the unexpectedly resigned Kugler as a Federal Reserve governor may add another dovish official to the Fed.

Michael Feroli, Chief U.S. Economist at JP Morgan, stated that if Moore is approved as a Federal Reserve governor before the September meeting, there could be at least three dissenting votes against keeping rates unchanged at that meeting. He said, "For Powell, the risk management at the next meeting may not just be about balancing employment and inflation risks. We now believe that the path of least resistance is to bring the next 25 basis point rate cut forward to September."

Bloomberg strategist Cameron Crise noted, "The market is still pricing in nearly two rate cuts this year, rather than three. Although a September rate cut is almost seen as a done deal. To significantly change this expectation, it may require not only an unexpected rise in Tuesday's inflation data but also an unexpected rise in the August non-farm payroll data released on September 5."

However, despite forecasts indicating that inflation will remain above the Federal Reserve's 2% target, Roger Hallam, Global Rates Head at Vanguard Asset Management, expects that unless there is a significant upward inflation shock, policymakers will focus on signs of weakness in the labor market. He stated, "At critical moments, the Federal Reserve will prioritize the labor market in non-extreme inflation scenarios. The labor market has already shown enough signs of weakness, and the probability of a rate cut in September has significantly increased."