Is the Fed’s rate-cutting cycle over?

Author: Felix Jauvin, Blockworks; Translator: Baishui, Golden Finance

Back in September, the market was predicting one of the most aggressive rate cut cycles I have ever seen, with multiple 50 basis point cuts that would quickly bring the federal funds rate to 3% by 2025. Fast forward to today, the situation is completely different, and only one or two rate cuts are expected in 2025 at most.

Let's take a deeper look at what is driving this change and what the expected results are.

The chart below is a comparison of the effective federal funds rate (EFFR) and the two-year US Treasury bond.

By comparing these two yields, we can draw a few conclusions:

• Over the past two years, we have seen many times that the two-year rate has already reflected the upcoming aggressive rate cut cycle (such as the two-year rate falling below the EFFR).

• For the first time since mid-2022, we have seen the two yields flat. This means that the market is pricing in a rate cut cycle that is basically over, but it also does not see any possibility of rate hikes.

One big driver of talk of a quick end to this short-lived rate-cutting cycle is surprisingly stubborn inflation. As we saw in the December Summary of Economic Projections, FOMC members have moved from inflation being roughly balanced to seeing risks skewed to the upside.

Combined with the fact that the labor market is now proving more resilient and robust than when the FOMC began cutting rates in September, these factors are tilting the distribution of possible outcomes more toward a hawkish monetary reaction function.

Put these factors together and you can see why there is growing confidence that the rate cutting cycle is over.

That being said, there are still dovish voices within the FOMC.

In his speech this week, President Waller mentioned that he still believes there will be rate cuts this year: "So what is my view? If the outlook develops as I have described here, I would support continuing to reduce our policy rate through 2025. The pace of these reductions will depend on the progress we make on inflation while preventing a weakening in the labor market."

Like the past two years, 2025 will be another year of extremes, with markets moving from aggressive hawkish pricing to aggressive dovish pricing.

Investors need to decide quickly whether to try to ride these sentiment shifts or ignore them as noise.