Market Expects Only Two Fed Rate Cuts by 2025, 2-Year Treasury Yield Surges 12%

Traders have scaled back their bets on the Federal Reserve cutting interest rates this year, now expecting only two rate cuts by 2025. This shift in market sentiment is reflected in the recent decline of the 2-year U.S. Treasury yield, which surged by 12 basis points on Monday, briefly reaching 4%. This movement indicates a reduction in market expectations for the number of rate cuts by 2025.

The market's anticipation of rate cuts has diminished, with the latest swap contracts tracking the Federal Reserve's policy meetings indicating a cumulative reduction of only 55 basis points by December. This is a decrease from the previous week's estimate of nearly 75 basis points. Traders still anticipate the first rate cut of 25 basis points to occur in September. The rise in yields and the decreased certainty of rate cuts suggest a weakening of the bullish sentiment in the bond market. Recent tariff reduction measures are seen as a boost to the economy, leading to a significant rebound in risk assets and reducing the appeal of U.S. Treasuries.

Since the Federal Reserve's latest meeting and Chairman Jerome Powell's adoption of a "wait-and-see" approach, market expectations for the Fed's policy path have been continually adjusted. Powell emphasized the need to assess the impact of tariff changes on inflation and economic growth. Over the past week, the 2-year Treasury yield has risen from a low of 3.55%, while the 5-year Treasury yield has increased from approximately 3.85% to 4.11%.

"The market tends to overreact, and now capital is flowing into risk assets," said Ed Al-Hussainy, a rate strategist at Columbia Threadneedle Investments. The firm is inclined to sell short-term bonds, and Al-Hussainy noted that the 2-year Treasury would only become attractive if the market expects fewer than two rate cuts this year.

Wall Street remains divided on the extent of the Federal Reserve's rate cuts this year, reflecting significant uncertainty in monetary policy. Economists' predictions range from no rate cuts to as many as 125 basis points. Several major banks' economists forecast that the Federal Reserve will cut rates two to three times this year, potentially starting as early as July or September.