- Treasury yields slipped after a cooler inflation print strengthened expectations the Fed could start cutting rates around June.
- December 2025 CPI held at 2.7% year over year and core inflation eased to about 2.6%, reinforcing a gradual disinflation trend.
- Officials called the data encouraging but stressed inflation is still above target, leaving the pace and timing of cuts dependent on incoming data.
- A Justice Department probe involving Fed Chair Jerome Powell has raised concerns about Fed independence and policy credibility.
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The latest inflation release has instilled cautious optimism in fixed income markets. While headline inflation remains well above the Fed
target of 2%, the December 2025 figures—0.3% month-to-month and 2.7% year-over-year—showed no signs of accelerating inflationary pressures. Core inflation mirrored this stability at 2.6% YoY, slightly under market expectations. The absence of a sharp price spike has given Treasury investors reason to believe that monetary policy may be entering a easing cycle later this year.
In response, Treasury yields—especially those at the short end of the curve (2- and 5-year tenors)—fell sharply (around 3 bps), signaling stronger market conviction that rate cuts might begin around mid-year. The yield curve’s flattening at longer maturities (e.g., the 10-year yield dropped ~1 bp) suggests investors remain skeptical about sustained disinflation, longer-term growth, and inflation drivers like shelter and services.
Fed officials have largely avoided committing to a fixed timetable, noting that while inflation is cooling, it remains above the target and that policy effects have lags. The Fed is likely to prioritize incoming economic data—particularly labor market strength, producer price indexes, and inflation expectations—before allowing rate cuts. Markets appear to price in one or multiple cuts by year-end, with June being a key marker, though some strategists caution the Fed may move more cautiously.
Overlaying these economic signals are political developments: the Justice Department’s investigation into Powell’s former testimony over Federal Reserve buildings’ renovations has raised red flags among investors regarding central bank independence. This tension could erode trust and amplify volatility around monetary policy announcements. Thus, while markets are leaning toward a more dovish outlook, risks to credibility remain material.
Strategically, fixed income investors should differentiate between short- and long-duration positions: short-term rates are sensitive to Fed policy and likely to adjust first, whereas long-end returns depend heavily on growth, inflation outlook, and fiscal risks. Equity valuations may gain from lower discount rates, but only if earnings are resilient and inflation remains under control. Meanwhile, uncertainty—both in data (e.g., services inflation) and politics—suggests dispersion in forecasts and policy paths.
Open questions include the durability of disinflation in core sectors like shelter and services, whether political pressure on the Fed will subside or influence decision-making, and how global and fiscal risks may reshape market expectations for long-term yields despite a potential easing policy cycle.
Supporting Notes
- December headline CPI rose 2.7% YoY; core CPI rose 2.6%, both matching or slightly below market forecasts.
- Monthly inflation rose 0.3% overall in December; core inflation (excluding food and energy) rose 0.2%.
- Treasuries rallied: short-term yields (2-,5-year) fell ~3 bps after the inflation report; the 10-year yield fell about 1 bp.
- Fed officials described December inflation data as “encouraging,” highlighting that though inflation is still above target, it does not seem to be accelerating.
- Markets currently expect the first rate cut probably in June, but timing remains in flux and subject to future data.
- Fed Chair Jerome Powell is facing a Department of Justice investigation over renovations, bringing concerns about central bank independence and casting shadows over policy credibility.