The Two-Year Treasury Signal: Is the Fed Ready to Cut Rates in 2025?

The two-year U.S. Treasury yield, a barometer of short-term market expectations for the Federal Reserve’s policy rate, has become the focal point of a high-stakes debate. Treasury Secretary Scott Bessent has argued that its recent inversion relative to the Fed’s Federal Funds rate signals the central bank should prepare to cut rates as early as 2025. But as inflation remains elevated and fiscal headwinds loom, the Fed’s cautious leadership is pushing back. The clash highlights a critical question: Can the Treasury’s market-driven signals override the Fed’s data-dependent approach?

The Inversion as a Warning Bell

Bessent’s case hinges on the two-year Treasury yield’s relationship to the Fed Funds rate. When the yield drops below the Fed’s target rate—a phenomenon known as inversion—it typically reflects markets pricing in future rate cuts. This inversion, Bessent argues, is a “clear signal” that the Fed must act preemptively to avoid economic stagnation.

The two-year yield has trended downward since the Fed’s September 2023 “jumbo” rate cut, which brought the Funds rate down to 4.6%. Yet markets are now pricing in a path lower still, with the yield currently at 4.1%. . This divergence suggests investors expect the Fed to resume easing by 2025, even as policymakers stress patience.

A Fed Divided: Caution vs. Market Pressure

While Bessent sees the inversion as a mandate for action, Fed officials like Vice Chair Philip Jefferson and Dallas Fed President Lorie Logan are skeptical. Jefferson has emphasized a “gradual reduction” in monetary policy tightening, warning against overreacting to short-term market signals. Logan, meanwhile, has linked rate cuts to inflation settling near 2% and a cooling labor market. Both stress the need to avoid premature easing that could reignite inflation.

The Fed’s stance is not without merit. Core inflation, excluding volatile food and energy prices, remains at 3.7%—well above the 2% target. A reveals the stubborn persistence of price pressures. Until these metrics improve, the Fed is unlikely to heed Bessent’s call for aggressive cuts.

Bessent’s Economic Crosswinds

Bessent’s optimism faces headwinds beyond the Fed’s resistance. The Trump administration’s trade policies, including tariffs on China and Mexico, risk inflating import costs. The Congressional Budget Office (CBO) projects these tariffs alone could add 0.3% to annual inflation by 2025. Meanwhile, deportation policies targeting undocumented workers threaten to tighten labor markets, driving up wage growth. A underscores how these policies could push long-term borrowing costs higher, complicating Bessent’s goal of stabilizing the 10-year yield.

Debt Management and the Term Premium

Bessent’s strategy to control the 10-year yield includes maintaining a steady issuance of Treasury debt while avoiding short-term instruments. But the CBO’s projections for a $2.3 trillion deficit in 2025—up from $1.8 trillion in 2023—could force the Treasury to issue more long-term debt. This surge in supply might push yields upward, counteracting Bessent’s efforts.

Regulatory tools, such as Fed Governor Michelle Bowman’s proposal to increase bank leverage ratios, aim to boost liquidity in Treasury markets. Yet these measures are indirect, and their effectiveness remains unproven. A reveals how market anxiety over fiscal policy could amplify this premium, destabilizing yields.

Conclusion: A Tug-of-War Over Borrowing Costs

Bessent’s vision of Fed rate cuts in 2025 hinges on a narrow set of assumptions: that inflation will cool sufficiently, that markets are right about the Fed’s path, and that fiscal policies won’t derail progress. But with the Fed’s inflation target unmet and trade tensions simmering, the odds of a smooth glide path are dim.

The data paints a mixed picture. While the two-year yield’s inversion signals easing expectations, the Fed’s inflation metrics show no clear descent toward 2%. The CBO’s deficit forecasts suggest fiscal pressures will grow, while the term premium’s elevated state hints at market skepticism. If Bessent’s camp hopes to win this battle, they’ll need more than inverted yields—they’ll need a Fed willing to gamble on a fragile economic recovery. For now, the odds remain stacked against them.

. History suggests markets often overpredict rate cuts, but with Bessent’s influence, this cycle could prove different—or more turbulent.