The Notion of Aggressively Dovish Fed Fades as U.S. Inflation Report Looms

• Traders are pricing in less than 50 basis points of Fed interest-rate cuts by year-end, down from 75 bps early last week.
• Bitcoin's rally stalls as Treasury yields and the dollar index rise.
• Though crucial, Thursday's U.S. inflation data may not cause tectonic shifts in the market. About three weeks ago, the U.S. Federal Reserve (Fed) delivered an outsized 50 basis point interest-rate cut, interpreted by many analysts as signaling more easing ahead. The move triggered a wave of optimism across financial markets, with analysts predicting 75 bps of additional cuts and a $100,000 price for bitcoin (BTC), currently around $63,000, by year-end.

That euphoria's taken a knock as last week's stronger-than-expected U.S. jobs and PMI services reports forced traders to reassess the supposedly bullish expectations for bigger and faster rate reductions.

Traders are now pricing in less than 50 basis points of easing in November and December, according to data tracked by trading platform Pepperstone's senior research strategist, Michael Brown. The reading is consistent with the Fed's dot plot chart published in September, which showed quarter-point rate cuts or one half-point cut by the end of the year.

Recall that the year began with traders expecting over 100 bps of rate cuts and a bitcoin rally that saw prices hit record highs above $73,000 on the back of optimism over the approval of spot BTC ETFs in the U.S. Later, markets trimmed the bets to three 25 bps rate cuts for the second half.

The recent hawkish repricing of Fed rate expectations is also evident in Treasuries. Early Monday, the yield on the U.S. two-year note rose to 4%, the highest since Aug. 23, amounting to a cumulative gain of 50 basis points since Sept. 25. The 10-year Treasury note also tapped the 4% mark, data from charting platform TradingView show.

Meanwhile, the dollar index (DXY), which gauges the greenback's exchange rate against major fiat currencies, including the euro, has risen over 1.5% to 102.62.

Other things being equal, the hardening of Treasury yields and a stronger dollar often lead to financial tightening and reduced investor appetite for riskier investments like cryptocurrencies and technology stocks.

After the Fed cut rates on Sept. 18, BTC picked up a strong bid, rising over 10% to $66,500 by Sept. 27, CoinDesk data show. Since then, the rally has stalled, with the cryptocurrency trading below $63,000 at press time.

Focus on Thursday's CPI

All eyes are now on Thursday's U.S. September consumer price index data, according to QCP Capital.

"With the recent strong U.S. wage and jobs numbers, the market will be paying close attention to this [CPI] print for any signs of an uptick in inflation. Fed rate cut expectations have shifted from 50 bps to 25 bps in just a week and this week's data may determine if further cuts are priced out," the Singapore-based firm said in a market update.

According to RBC Economics, the report is likely to show the cost of living decelerated to 2.2% year-on-year in September from 2.5% in August. Core inflation, which excludes volatile energy and food components, likely edged down to 3.1% from 3.2%.

Even so, the report may do little to stall or reverse the ongoing DXY recovery and hawkish repricing of U.S. rate cuts, meaning markets may favor defensive USD positioning ahead of the Nov. 5 U.S. presidential election, according to ING.

"Again, 0.1% or 0.3% [CPI] should not trigger tectonic shifts in markets now that the focus is on the Fed's employment side of the mandate, but some dollar volatility should follow any out-of-consensus print," analysts at ING said in a market update.

Edited by Sheldon Reback.