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(Bloomberg) -- Bond investors are coming to terms with Jerome Powell’s message that the Federal Reserve is in no-rush to start cutting interest rates.
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After Powell reiterated the central bank’s wait-and-see approach to easing monetary policy last week, traders aggressively boosted bets that the benchmark lending rate will be cut by less than a three-quarter point in 2025, with the first move starting only in July.
Whether the wager holds will depend on the trajectory of the US economy and inflation in the coming weeks. Details on the trade talks between US and China this weekend and a reading on consumer prices on Tuesday may have investors stepping back from their latest views. Powell said as policymakers look for more clarity on tariff policies, the risks of higher inflation and unemployment have increased due to President Donald Trump’s sweeping levies.
“The bond market’s accepting the fact that inflation is going to be higher than kind of initially anticipated, and that is a complicating factor for investors’ belief that the Fed will step in and cut rates,” said Greg Peters, who helps manage more than $850 billion as co-chief investment officer at PGIM Fixed Income.
Options traders are piling into more hedges to protect against the Fed potentially not easing this year, with one growing position that anticipates the central bank won’t cut rates in 2025. Before the latest jobs data showed resilient hiring in April, swaps had indicated strong odds for a rate cut as soon as next month.
Meanwhile, Wall Street’s calls of zero to as much as a 1.25 point rate-cut this year also highlight the uncertainty around the Fed’s policy path. Several big bank economists forecast either two or three reductions this year, beginning in July or September.
“The market’s pricing of rate cuts is quite overdone. Absent a recession the Fed will only cut rates 25 basis points more,” said Sonal Desai, chief investment officer for fixed income at Franklin Templeton. Treasury yields are rangebound as the market waits for more clarity on trade policy, “which I don’t think we’ll get for a rather extended period,” she added.
The two-year Treasury yield, more sensitive to Fed policy expectations, climbed 33 basis points from this month’s low of 3.55%. The move extended at the end of the week as the US and UK announced a trade deal, boosting risk appetite, and as Trump hinted at lower tariffs for China if talks progress.