US Treasury traders reduce rate cut bets as Powell states the Federal Reserve still needs to see progress in controlling inflation

How does Powell’s speech influence market expectations for rate cuts?

Source: Global Market Report

The Federal Reserve has been signaling for months that further rate cuts are not guaranteed.

On Wednesday, U.S. bond traders finally fully absorbed this message.

After Fed Chair Jerome Powell’s speech, U.S. Treasury prices fell, and short-term yields surged to their highest levels since August. Powell said that policymakers need to see progress on inflation before lowering the target interest rate further. “If we don’t see progress on inflation, we won’t cut rates,” Powell told reporters after the central bank held rates steady for the second consecutive meeting.

On the surface, policymakers maintained their median expectation of one rate cut this year, but ultimately, traders’ judgments are driven by Powell’s comments. Currently, the rate market shows that even a single rate cut has nearly a 50/50 chance, with the Middle East conflict and soaring oil prices intensifying this heated debate.

The two-year Treasury yield, most sensitive to Fed policy changes, rose as much as 10 basis points to nearly 3.78%, hitting a seven-month high. The 10-year Treasury yield also climbed 7 basis points to 4.27%.

This isn’t the first time markets have had to adjust due to Fed signals, but the recent volatility has been particularly intense. Powell’s remarks indicated that the overall trend has “significantly” tilted toward fewer rate cuts, and, as in January, discussions about the possibility of rate hikes have re-emerged.

“If you look at the wording changes over the past six months, you’ll see that the belief in rate cuts has shifted from ‘perhaps’ to ‘we might discuss rate hikes,’” said Robert Tipp, Chief Investment Strategist and Head of Global Bonds at PGIM.

Just three weeks ago, fears about AI disruptions and cracks in the private credit market caused panic in financial markets, with traders expecting the Fed to cut rates three times this year. This anxiety drove U.S. Treasuries to nearly rebound in February, posting their best monthly performance in nearly a year. However, the declines since March have almost erased those gains.

Driven by soaring oil prices, the two-year yield has risen 38 basis points this month, potentially marking the largest monthly increase since October 2024. Currently, the yield level above 3.75% has persisted for several trading days, higher than the actual Federal Funds Rate, a situation last seen in 2023 when the Fed was raising rates.

The Fed’s updated dot plot shows policymakers expect one 25-basis-point rate cut in 2026 and 2027, weighing the risks of economic growth and inflation. The additional uncertainty from the Middle East conflict has heightened traders’ concerns that rising energy prices could exacerbate inflation—currently above the Fed’s target—or ultimately suppress economic growth.

Dan Carter, Senior Portfolio Manager at Fort Washington Investment Advisors, said that compared to the negative growth impact from oil shocks, Powell “seems more concerned about inflation.” Carter believes that short- to medium-term Treasury yields are “attractive” because “the likelihood of rate hikes is low.”