After the Federal Reserve's significant 50 basis point rate cut in September, traders originally expected at least another 25 basis point cut later this year. However, current trading in the swap market indicates a significantly increased possibility that the Fed will keep rates unchanged in the remaining two meetings this year. Analysts suggest that investors have shifted from overestimating rate cuts by the Fed to underestimating them, signaling a swing in the opposite direction
Strong economic data and expectations of rekindled inflation due to Trump's re-election have prompted traders to weaken their expectations for the magnitude and speed of interest rate cuts, with analysts warning that the market may have overreacted.
This week, US Treasuries were sold off, with yields rising across the board. The yield on the 10-year US Treasury rose by about 15 basis points, reaching its highest level since July.
A series of changes in the US market have also impacted global markets: the US dollar has risen by over 3% in the past month, pushing the USD/JPY above 150. Japanese officials have issued warnings about the weak yen, and the Mexican peso has also come under pressure.
The sharp decline in US Treasuries is a result of investors significantly cooling off their expectations for interest rate cuts. After the Fed's aggressive 50 basis point rate cut in September, traders originally expected at least another 25 basis point cut this year. However, current trading in the swaps market shows a significantly increased likelihood that the Fed will keep rates unchanged in the remaining two meetings this year.
Analysts point out that investors are shifting from overestimating interest rate cuts by the Fed at the beginning of the year to now underestimating them at the other extreme.
The pendulum swings the other way
Analysts warn that US Treasury yields may have risen too high, while most major central banks in the US and globally still expect to continue their rate-cutting cycles.
Rob Burrows, government bond fund manager at M&G Investments, stated that the dovish expectations for Fed rate cuts earlier in the year were driven by investors' fear of "missing out on the rate-cutting cycle," stemming from the low-rate era post-global financial crisis. When strong employment data supports the view that drastic rate cuts are not needed, the market gets "spooked."
Jim Caron, Chief Investment Officer of the Portfolio Solutions department at Morgan Stanley Investment Management, also believes that inflation has been declining and the Fed still expects rate cuts.
Ed Al-Hussainy, Senior Global Rates Strategist at Columbia Threadneedle Investments, stated that from investors overestimating the magnitude of Fed rate cuts to now underestimating them, "the pendulum has swung in the other direction":
"My sense is that in the current market, they are so sensitive to the increase in fiscal deficits that they have underestimated the actions the Fed must take."
Uncertainty in the US Treasury market is "locked in"
Against the backdrop of strong US economic data, rising bond yields, and market volatility returning, analysts have differing views on the Fed's rate-cutting path.
Akshay Singal, Global Head of Short-Term Interest Rate Trading at Citigroup, stated that the path of rate cuts is "much broader than in the past," with the Fed possibly not cutting rates at all by 2025, or cutting rates by 125 basis points or even more. Singal added:
"Uncertainty comes from multiple aspects - economic fundamentals, the Fed's response, and the political environment that could drive changes in fiscal policy."
William Vaughan, Deputy Portfolio Manager at Brandywine Global Investment Management, stated that **global bond markets are "locked in volatility in the short to medium term," as investors await the UK budget, US elections, and monetary policy decisions from key central banks globally In addition, the expectation of Trump's victory has increased, also increasing the market's expectation of reigniting inflation, thereby putting upward pressure on bond yields.
Currently, US bond investors are preparing for the uncertainty during the election period and the economy. Caron stated:
"Ultimately, US bond yields may remain at a constrained level, which is unlikely to be the start of a new trend of rising yields, but rather just an adjustment."