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Bond traders on edge with inflation readings to shed light on Fed policy

There will be updates on producer and consumer price indexes this week, with Friday's CPI report expected to show inflation picked up in April

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Mr Powell says officials don't "see a strong case" for moving rates in either direction. Futures traders largely seem to agree but they still expect a quarter-point cut as the next move by the Federal Reserve.

New York

BOND traders will have one word on their minds as they gear up for the latest readings on inflation - "transitory". That's how Federal Reserve chairman Jerome Powell characterised the factors behind muted price pressures after last week's policy meeting, where officials kept interest rates unchanged. Markets whipsawed on his comments, with benchmark 10-year Treasury yields bouncing off their lowest levels in a month.

This week, traders get to see if Mr Powell's right, with updates on producer and consumer price indexes. Friday's CPI report is expected to show that inflation picked up last month. Still, the bar will be high when it comes to altering market expectations for the Fed's path, according to TD Securities. Mr Powell said officials don't "see a strong case" for moving rates in either direction, and futures traders seem to agree - they still expect a quarter-point cut as the next move, but it's not fully priced in until mid-2020.

"CPI will be quite crucial, as Powell hinted at some of the transitory factors weighing down inflation," said Gennadiy Goldberg, a senior US rates strategist. "A stronger inflation report could help push back on some of the pricing for rate cuts this year, though I think some doubts will remain since this will be viewed as only one reading." That scepticism was evident Friday. Despite a robust US jobs report, traders barely changed expectations for when a cut would be fully priced in, as they zeroed in on tame earnings growth. Yields on 10-year Treasuries ended the week at 2.53 per cent, after swinging in a 12-basis-point weekly range - the largest span in over a month.

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Schroder Investment Management's Lisa Hornby is of a similar mind when it comes to the resilience of rate-cut wagers. Though inflation is "the most important data we have to look at", the portfolio manager says it will take more than one report to sway the market.

"It will take a lot to move the Fed and therefore, market pricing," she said. "The Fed is firmly on hold until a direction comes clear as far as the trajectory of inflation."

She anticipates range-bound trading, but sees scope for higher yields. She said she would buy should 10-year yields exceed 2.7 per cent in the next few weeks - a level last seen in March.

Consumer prices, excluding food and energy, probably rose 0.2 per cent in April from the prior month, and 2.1 per cent on a yearly basis, a slightly quicker pace than seen in March, according to the median forecasts in a Bloomberg survey. Any surprise to the upside could douse yield-curve steepening bets, according to Mr Goldberg.

"A firmer inflation print will help yields rebound somewhat, but that rebound may be concentrated in the front-end of the curve, which could lead the curve to flatten further," he said.

More than a half-dozen Fed policymakers are scheduled to speak this week, including Mr Powell. BLOOMBERG