Bond traders are beginning to bet on a decline in the U.S. Treasury market, with the upcoming release of key inflation data expected to provide further clues on the Federal Reserve's monetary policy path.

Employment data released late last week pushed the bond market lower and raised yields, as investors dialed back bets on the Federal Reserve having to continue aggressive rate cuts this year to prevent a weakening labor market. With concerns about U.S. employment now subsiding, attention will shift to whether consumer prices are under control.

"Inflation 'should be relatively mild, so there should be no surprises,'" said Kim Rupert, an economist at Action Economics. "But that's not to say it won't be a complete surprise; it's clear that if the data comes in higher than expected, it could exacerbate the bearish reaction triggered by the release of the non-farm payrolls report."

The consensus forecast compiled by Bloomberg estimates a year-over-year increase in consumer prices excluding food and energy of 3.2%. Michael de Pass, global head of interest rate trading at Castle Securities, said in an interview that if Thursday's inflation report matches this expectation, his forecast of another 25 basis points rate cut this year is possible, as inflation remains well above the Federal Reserve's 2% target.

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"We ultimately find ourselves in a situation where inflation remains sticky, above target levels, and the pace of rate cuts slows relative to market bets," de Pass said.

Swaps traders are now betting on less than a 100% chance of at least another 50 basis points rate cut by the Federal Reserve this year, with about 47 basis points of cuts factored in. In the options market, new positions are biased towards hedging a scenario where the Federal Reserve cuts rates by only 25 basis points at its November meeting and then stands pat in December.

Minutes from the Federal Reserve's September meeting released on Wednesday showed that Chairman Jerome Powell faced some resistance in cutting rates by 50 basis points, as more than one of his colleagues preferred a 25 basis point cut.

After five consecutive months of gains, the U.S. Treasury market has fallen 1.3% so far this month. This has pushed yields on Treasuries across maturities close to or above 4%, with the benchmark 10-year Treasury yield rising nearly 30 basis points last week.

In addition to CPI data, the market will also digest the issuance of $22 billion in 30-year Treasury bonds on Thursday. The market has had a lukewarm response to the $39 billion in 10-year Treasury bonds issued on Wednesday and the $58 billion in 3-year Treasury bonds issued on Tuesday.

Since the Federal Reserve cut rates by 50 basis points on September 18, the policy-sensitive 2-year U.S. Treasury yield has fluctuated in a range just above 0.5 percentage points. The yield fell as low as 3.5% on September 25 and touched a high of 4.02% last Friday as traders reacted to strong employment data."Opinions are so widespread and diverse that we will once again see the market react aggressively to one or two data points," de Pass said, "We will once again see considerable fluctuations at the front end of the curve."