- US interest futures remained volatile, with a clear divergence between 2-year and 10-year yields.
- The political pressure on the Fed, combined with dismal US data, may result in a quicker easing than expected.
- Market participants are eyeing the US Core PCE Index report due today for further impetus.
US interest futures remained volatile this week, reflecting a divergence between long-term and short-term expectations for Fed policy. The 2-year and 10-year Treasury notes have shown a clear divergence, highlighting the scale and timing of rate cuts expected in the second half of 2025.
The 2-year Treasury note, which closely tracks Fed policy expectations, saw yields decline from the levels held earlier this month. The fall reflects confidence that the Fed may cut rates as soon as September. Futures markets now price in a 60 bps rate cut by the end of the year. The July meeting carries around a 20% probability for the move. The sentiment has been driven by the political pressure on the Fed, weaker US GDP, and cooling inflation.
The revised US GDP for the first quarter showed a 0.5% contraction, which is deeper than the estimated 0.2%. Meanwhile, the Fed Chair reiterated in his testimony before Congress that the central bank will not cut rates hastily but will remain flexible. However, markets have become more sensitive after President Trump started his criticism of the Fed again, with a threat to replace the Fed Chair as soon as September. Traders are now pricing in a more dovish Fed, leading to quicker easing than expected.
Meanwhile, the 10-year Treasury yield remained firm near 4.35%, marginally lower than the highs. This resilience suggests that long-term inflation concerns have not yet abated, particularly given the uncertainty surrounding tariffs and energy prices. US Durable goods orders surged to a decade high, beating estimates with a jump of 16.4%. While it doesn’t kill the broader concerns, it justifies the flattening yields.
The spread between 2-year and 10-year notes has begun to narrow but remains inverted, indicating a risk of recession and potential policy misalignment. However, the inversion magnitude has lessened recently. It reflects the market’s belief that short-term rates may fall more sharply than long-term rates by the end of 2025.
The upcoming PCE inflation report and Powell’s forward guidance will be pivotal in determining whether the market’s current pricing of two or more cuts in 2025 will hold or be revised.
