Is the Fed’s interest rate cutting cycle over?

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

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

Let’s take a deeper look at what’s driving this change and what to expect.

The chart below compares the effective federal funds rate (EFFR) to the two- year U.S. Treasury note.

By comparing these two yields, we can draw some conclusions:

• Over the past two years, we have seen many times where the two-year rate has priced in an upcoming cycle of aggressive rate cuts (such as when the two-year rate fell below the EFFR).

• For the first time since mid-2022, we see these two yields level. That means the market is pricing in a rate-cutting cycle that's largely over, but it also doesn't see any possibility of a rate hike.

One driver of talk of a quick end to this brief rate-cutting cycle is surprisingly stubborn inflation. As we saw in the December summary of economic forecasts, FOMC members have moved from a broadly balanced outlook on inflation 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 interest rates in September, these factors are tilting the distribution of likely outcomes more toward a hawkish monetary reaction function.

Take 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, Governor Waller mentioned that he still believes in a rate cut this year: "So what is my view? If the outlook develops as I have described here, I will support continued reductions in our policy in 2025 Interest rates. The pace of rate cuts will depend on the progress we make on inflation while preventing a weakening of the labor market."

Like the last two years, 2025 is shaping up to 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 dismiss them as noise.