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(Bloomberg) -- Bond traders are girding for a high-stakes US inflation report that has the potential to dent their wagers on a deep series of Federal Reserve interest-rate cuts starting this month and extending into 2026.

Soft jobs data and tame producer-price figures have led traders to view a quarter-point reduction at the Fed’s Sept. 16-17 meeting as a lock, with perhaps two more such steps to follow by year-end. But beyond that, the market has shifted how it sees the balance of risks in the economy — positioning now favors officials eventually slashing rates below what’s seen as a neutral level, to the point that policy spurs growth to head off a recession.

That marks a sea change because for much of the past year, traders hesitated to wager on that magnitude of easing with inflation proving sticky. It’s a setup that’s heightening scrutiny of Thursday’s consumer-price index report, which is projected to show a core annual reading well above the Fed’s target. After a monthlong rally that drove US two-year yields to the lowest since April, the risk is that investors have turned too bullish.

“The front-end has priced for a weaker economy, not any focus on inflation,” said Ed Al-Hussainy, a portfolio manager at Columbia Threadneedle’s Total Return Bond Fund. “If the focus comes back to inflation, if the number is hot, the front-end will be a bit vulnerable.”

A slowing jobs market has prompted Wall Street to price a more aggressive trajectory of rate cuts, with a growing number of economists now seeing a quarter-point rate cut at each of this year’s three remaining meetings, from a previous forecast of just two cuts. Between now and this time next year, traders expect the Fed to deliver at least five 25 basis-point cuts.

A report Wednesday showed producer prices unexpectedly fell in August. Yields dropped on the data, with those on two-year Treasuries, the maturity most closely linked to the outlook for Fed policy, sinking as much as five basis points Wednesday to 3.51%. They were steady at 3.54% in London on Thursday.

What Bloomberg strategists say....

“PPI offered less than no impediment to Fed easing, though the components that feed into PCE were less dovish than the unexpected drop in the headline and core indexes.”

• Cameron Crise, macro strategist, Markets Live

For the full analysis, click here.

Traders are leaning toward three quarter-point cuts by year-end, and potentially several more reductions of that size by around this point of 2026. That would push the funds rate just under the 3% level that officials in June forecast for their longer-run rate, seen as a proxy for the so-called neutral rate that neither spurs nor slows growth.

CPI Hurdle

That view of the Fed’s path has emerged even as core consumer-price growth is forecast by economists to remain at an annualized 3.1% rate in August.

“It’s incredible that you have the market pricing such a high degree of cuts — such a very, very fast trajectory of cuts — alongside sticky inflation,” said Meghan Swiber, Bank of America Corp.’s director of US rates strategy. “We’re kind of thinking about the 3% as a ceiling in terms of how the market is going to be trading the trough of the cycle.”

That dynamic could continue if CPI shows strength that’s more driven by goods tariff-related inflation, which some Fed members say may prove temporary, she said.

The median of officials’ projections released in June showed the funds rate ending 2026 and 2027 at 3.63% and 3.38%, respectively. The current rate is set in a range from 4.25% to 4.5%. Next week, officials will also release fresh rate forecasts, known as their dot plot.

With the Fed expected to resume cutting and other developed-nation peers having slashed borrowing costs this year, global bonds have been rallying. Longer-term debt has lagged, however, as investors remain wary over government spending. US 30-year yields climbed to about 5% last week, the highest since July, before signs of labor-market softening triggered a retreat.

Trump Pressure

Of course, part of the market’s positioning reflects President Donald Trump’s repeated criticism of Fed Chair Jerome Powell as being too slow to cut, and the president’s broader push to sway the central bank.

“There’s also some of the political economy here in terms of the outlook for the funds rate over the next year, as it seems obvious that a requirement for a job at the Fed now is that you are going to cut interest rates, and by a lot,” said Benson Durham, head of global asset allocation at Piper Sandler and a former Fed economist.

For now, Powell and other officials have said their key rate is above neutral, meaning it’s restricting the economy to cool inflation.

Matthew Hornbach, global head of macro strategy at Morgan Stanley, said in a note with colleagues that investor concern about downside risks to the economy will grow, fueling demands for Fed easing.

“We think investors will drive markets to price in a trough policy rate from the Fed well below the September 2024 nadir,” Hornbach and his colleagues wrote. They were referring to last year when traders saw the funds rate falling in the cycle to around 2.7%.

--With assistance from Naomi Tajitsu.

(Updates with details on Fed rate pricing in fifth paragraph.)