Traders See Federal Reserve Cutting Rates Just Twice In 2025 On Cooling Trade War

Traders lowered their bets on the Federal Reserve's interest-rate cuts this year, pricing in just two reductions for 2025 after the US and China agreed to cut tariffs and moderate their trade war.

Swaps that track upcoming central bank meetings showed just 55 basis points of easing by December, down from near 75 basis points last week. Traders still see the first quarter-point cut in September. The policy-sensitive two-year yield rose as much as 12 basis points Monday to back above 4%, as traders pulled back their estimates of rate cuts for 2025. 

The rise in yields combined with decreasing certainty over rate cuts reflect further weakening of bullish bond wagers as the latest reduction in tariffs is viewed as bolstering the economy. Risk assets rallied sharply to start the week, dimming the appeal of Treasuries.

The pullback in market expectations of the Fed's rate path has extended since the US central bank published its meeting statement and chair Jerome Powell advocated for a wait-and-see approach to assess how tariffs will impact inflation and growth. Over the past week, the two-year yield has climbed from a low of 3.55%, while the five-year note yield has risen to 4.11% from around 3.85%. 

“Markets are in the overshooting business and right now the money in motion is flowing to risk,” said Ed Al-Hussainy, rates strategist at Columbia Threadneedle Investment. The firm prefers selling the front-end, with Al Hussainy saying attractive cheaper levels for the two-year would require the market pricing in less than two cuts for this year.

Only last month, the bond market was pricing in four quarter-point cuts, with the Fed seen as resuming its easing cycle in June amid concerns that the trade war would derail the US economy. Now traders appear more aligned with the call of just two cuts in 2025 made by Fed officials in March, as employment remains firm and the prospect of sticky inflation is viewed as keeping the Fed on the sidelines.

In the past week, a contrarian wager that the Fed won't cut interest rates this year gained momentum in the rates options market, with open interest in a specific put option exceeding 275,000 contracts, according to CME data.

Wall Street views on how much Fed easing is likely to occur this year illustrates plenty of uncertainty around monetary policy, with economists calling a range from none to as much as 125 basis points of cuts. Several large-bank economists forecast either two or three cuts this year, beginning in July or September.

Economists at Citigroup Inc. for example pushed their prediction for the next rate cut from June to July following the announcement that the US will reduce its 145% tariff rate on Chinese goods to 30% for 90 days. The bank expects cuts at each meeting between July and January totaling 125 basis points.