According to the median forecast from the Fed officials' dot plot, interest rates are expected to be cut by just half a percentage point by 2025. This prediction aligns closely with Wall Street’s anticipated decline for the two-year Treasury yield
However, there remains a significant risk that the central bank may halt its easing cycle altogetherFollowing Chairman Jerome Powell’s remarks linking the prospects of further rate cuts to inflation trends, market reactions were swift, with the U.STreasury yield curve reaching its steepest level since June 2022. This shift underscores the market's acute sensitivity to changes in the Fed's monetary policy as well as growing concerns regarding the economic outlook.
Tracey Manzi, a senior investment strategist at Raymond James, conducted an in-depth analysis, observing that as the pace of rate cuts slows, short-term yields are likely to follow suitThe steepening of the yield curve, she suggests, is primarily driven by falling prices of long-term bonds
A median forecast from a group of 12 strategists indicates that the two-year Treasury yield is expected to dip by about 50 basis points to 3.75% within a yearHowever, it's important to note that since the Fed's latest economic projections were released on Wednesday, this yield has risen by nearly 10 basis points, highlighting the dynamic nature of market expectations and the immediate responses to the Fed's policy decisions.
Looking further out, strategists are also weighing predictions for the long-term 10-year U.STreasury yieldExpectations suggest that yields will hover around 4.52% on Friday and could decline to 4.25% by the end of 2025, approximately 25 basis points lower than current levelsNoel Dixon, a macro strategist at State Street, highlights that long-term bonds are likely to experience pressure regardless of whether they are evaluated through the lens of actual growth rates, inflation expectations, or term premium considerations
Notably, this strategist previously predicted that the 10-year yield could exceed 5% next year, indicating the market's inherent complexity and unpredictability.
In addition to analyzing the Federal Reserve’s monetary policy, financial experts are now directing their attention to fiscal policies and the central bank’s management of its holdings of U.STreasury securitiesThey are not only contemplating the potential evolution of fiscal policies but also considering how the cessation of balance sheet reduction by the Fed could lead to less supply in bonds, fueling heightened demand within the bond marketThis intertwining of factors significantly affects the supply-and-demand dynamics, guiding the movements of yields.
Barclays strategists, including Anshul Pradhan, succinctly outlined that “even if the Fed continues to lower policy rates, diminishing short-term yields, many factors supporting long-term yields remain intact”: higher neutral rates, increasing rate volatility, inflation risk premium, and substantial net issuance amid price-sensitive demand
This suggests that while the Fed's actions may influence short-term yields, the path of long-term yields is constrained by a multitude of complex factors.
Bloomberg strategists Ira FJersey and Will Hoffman added their insights, suggesting that stable economic performance early in 2025 could lead the Fed to gradually cut rates, with the peak rate potentially reaching 4%. They emphasized that it might only be under significant economic shifts that the 10-year yield strays from the 3.8%-4.7% rangeThis understanding offers market participants a vital reference framework to better comprehend and predict fluctuations within the 10-year Treasury yield.
Nevertheless, upcoming tariff and tax policies may serve as a “black swan” event that could disrupt existing forecasts on Wall Street
Pradhan pointed out that “higher tariffs and stricter immigration controls could slow growth while fueling inflation.” This perspective uncovers the dual impact of trade and immigration policies on both economic growth and inflation, a dynamic that will undoubtedly exacerbate uncertainties within the bond market.
Among various financial institutions, Morgan Stanley and Deutsche Bank have divergent views on the bond marketMorgan Stanley holds a notably optimistic outlook, asserting that investors face “downside risks to economic growth” coupled with “unexpected bull markets.” They anticipate a faster pace of Fed rate cuts than other banks, predicting the 10-year yield will decline to 3.55% by next December
Conversely, Deutsche Bank posits that the Fed will refrain from cutting rates in 2025. Matthew Raskin's team anticipates that, in an environment of strong economic growth, low unemployment, and sticky inflation, the 10-year yield could rise to 4.65%. They stated in a report, “the key catalyst supporting our view is our realization that inflation and labor market conditions necessitate a more restrictive Fed rate path than currently digested.” This duality of perspectives highlights how financial institutions can reach varying conclusions based on differing economic assumptions and analytical frameworks when confronted with a complex and fluctuating market environment.
The Fed's adjustments regarding the frequency of interest rate cuts next year, coupled with the interplay of numerous complex factors, render the future of the bond market uncertain
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