Interest rate cut expectations cool down! U.S. Treasury yields reach 4.5%, traders enter the market to "buy the dip"

On Friday, strong retail sales data cooled expectations for a Federal Reserve rate cut next month, and U.S. Treasury yields reached their highest levels in months. However, it turned out that high U.S. Treasury yields were quite attractive to bond investors.

In particular, the benchmark 10-year U.S. Treasury yield broke above 4.5% for the first time since May. Shortly thereafter, a large trade in 10-year Treasury futures indicated that this was cheap enough for at least one transaction — this large futures trade included 16,000 contracts of December 10-year Treasury bonds. Within hours, the yield returned to around 4.43%, increasing the value of that trade by about $5 million.

As crude oil and U.S. stock market benchmarks fell, boosting demand for bonds, yields continued to retreat from their daily highs. U.S. stock indices continued to rise this week, with the S&P 500 trading near record highs, and Federal Reserve Chairman Jerome Powell stated that there was clearly no need to rush into rate cuts. Bloomberg's measure of returns in the U.S. Treasury market fell this week, leaving the index up only 0.6% year-to-date.

Mike O'Rourke, Chief Market Strategist at Jonestrading, said, "A 10-year U.S. Treasury yield of 4.5% is very attractive. When the stock market falls, the safe-haven demand for U.S. Treasuries is strong."

Earlier declines in the Treasury market indicated that confidence in a rate cut next month had waned, as retail sales data was seen as supporting Powell's cautious stance. In the swap market, traders on Friday estimated that the likelihood of Federal Reserve policymakers opting for a 25 basis point rate cut at the December meeting was only about 50%, down from around 80% earlier in the week. As the bond market stabilized, the chances of a rate cut in December rose back to around 60%.

Bob Sinche, a veteran market researcher and Global Macro & Markets strategist, said, "Very few people support the Federal Reserve's easing policy. Chairman Powell raised uncertainties about the necessity of a rate cut in December, and today's data did not convincingly indicate that the Federal Reserve should cut rates immediately." Other Federal Reserve officials who spoke on Friday avoided sending clear signals about the situation in December. Boston Fed President Collins stated that the central bank's decisions will be guided by upcoming data, and rate cuts are still possible. Chicago Fed President Goolsbee indicated that as long as inflation continues to decline towards the central bank's 2% target, rates could "significantly" decrease in the next 12 to 18 months.

Since Trump won the U.S. presidential election on November 5, traders and economists have been reassessing their expectations for rate cuts throughout 2025. Some on Wall Street believe that his policy pledges (including raising tariffs) could spur inflation, thereby altering the Fed's course.

Swap contracts suggest that the Fed will cut rates by about 74 basis points by next December, and several Wall Street economists have lowered their forecasts for rate cuts in 2025. For instance, after Powell's speech on Thursday, JP Morgan hinted that policymakers might shift to slowing the pace of easing as early as January.

According to Guy LeBas, Chief Fixed Income Strategist at Janney Montgomery Scott, the possibility of a 25 basis point rate cut next month still exists, although the path thereafter is less certain. He stated, "I think they will do nothing in January. The Fed may slow down at that time, and then possibly implement quarterly rate cuts."