After months of stalemate, the markets are capitulating to the Federal Reserve's interest rate policy

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Investors have followed the Federal Reserve's expectation of cutting interest rates just three times this year, ending a months-long standoff between markets and the central bank.

After a series of economic data that suggested U.S. inflation remains stubbornly high, traders on Friday expected just three quarter-point interest rate cuts by the end of the year, according to data compiled by LSEG.

Before Tuesday's unexpected rise in U.S. inflation, investors had been betting on cuts of almost a full percentage point by December. In January they had priced in cuts of six to seven quarter points by the end of 2024.

“The market has been brought under control,” said Padhraic Garvey, head of research for the Americas at ING, arguing that persistent inflation has forced investors to give in.

U.S. stocks fell on Friday as traders cut bets on interest rate cuts, with the benchmark S&P 500 falling 0.6 percent and the tech-heavy Nasdaq Composite falling 1 percent.

Markets' alignment with the Fed's forecast of three rate cuts from its 23-year peak of 5.25 percent to 5.5 percent marks a major shift as investors prepare for the slower-than-expected decline in inflation in a crucial U.S -Set election year.

Markets now estimate the likelihood of a rate cut by June at just two in three. Last month they gave a 100 percent chance of a reduction by June.

“It is becoming increasingly likely that we will see a short and superficial interest rate cutting cycle this time,” said Mark Dowding, chief investment officer at RBC BlueBay Asset Management, who argued that the Fed may still need to keep interest rates relatively high to beat back inflation .

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In addition to the unexpected rise in inflation to 3.2 percent in February, separate data this week showed a 0.6 percent rise in producer prices from the previous month.

The Fed will meet next week to discuss the path of future interest rate cuts and update its forecasts for the rest of the year. Rates are expected to remain unchanged when it announces its decision on March 20.

Fed Chairman Jay Powell said this month that the central bank is “waiting to become more confident that inflation is sustainably moving to 2 percent” before cutting borrowing costs.

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“There is still a very real risk that robust economic data will deter the Fed from cutting interest rates in the coming months,” said Ellie Henderson, an economist at Investec.

The two-year Treasury yield, which reflects interest rate expectations, rose about 0.25 percentage points to 4.73 percent this week.

Official data last week showed the U.S. added more jobs than expected in February. Although the unemployment rate rose to 3.9 percent from 3.7 percent in the previous month, it is still low by historical standards.

Brent crude, the international benchmark, was trading 0.1 percent lower at $85.34 a barrel on Friday.

Additional reporting by Stephanie Stacey