Interest Rate Traders Signal Rate Cuts Straight Ahead
- cornerstoneams
- Aug 13
- 4 min read
Updated: Aug 15
The CME FedWatch tool tracks the probability of interest rate changes by the Fed as implied by the 30-day Fed Funds futures prices. This can simply be thought of as a gauge to measure the expectations of interest rate traders relative to expected Federal Reserve actions.
The expected probability of rate cuts straight ahead has gone to near certainty. The next Fed meeting is September 17th, so there is time for views to change. At this juncture though, a quarter percentage point cut is expected.
Above is a visual depicting a 94.4% probability of a quarter percentage point cut at the next Fed meeting. The current Fed Funds range is 4.25-4.50%. The large bar noting the 94% probability above is offering a new range of 4.0-4.25%.
The standout question, in light of the above expectation, is will the treasury bond market agree and chime in with the expected rate cuts?
If we assume the above actually occurs, as well as continues with follow-on cuts as 2025 closes out, will bond market participants concur with such moves by the Fed, or will they pull a “2024” on them and raise rates as the Fed is cutting?
Recollecting, prior to the election in 2024, the Fed cut rates via their Fed Funds rate three times from September through December. The first rate cut was one-half of one percent, with the two follow-on cuts equaling a quarter percent each time.
A full 1% reduction by the Fed in that period certainly did not impress bond market participants.
For their part, they moved rates in the opposite direction by just over 1%.
Above is a chart of the 10-year Treasury yield dating back to August of last year for some recent perspective.
The 10-Year Treasury note can be viewed as a benchmark interest rate instrument in that some interest rates within the economic system take their cue from its behavior.
This includes mortgage rates.
The Fed can cut interest rates all day long, if you will, but this offers zero guarantee mortgage rates, for example, will move in sync with them. This occurred with their most recent rate-cutting experience in 2024.
In the above chart our red arrow denotes what bond market participants did with interest rates, via the 10-year Treasury yield, all while the Fed was cutting rates by a full percent.
Bond participants were not impressed with the cutting campaign in light of the ongoing price inflation issue and showed their disapproval by selling off Treasuries, and in so doing, pushing up the benchmark 10-year Treasury yield by 1.2%. The Fed cut by 1%, while bond participants raised by 1%.
Our blue horizontal line highlights the general low area in the 10-year Treasury yield over the previous six months. That line will prove to be interesting as the Fed is expected to be moving toward cutting rates.
As offered, there is no guarantee bond market participants will chime in and move the
above yield below the blue line, which would show bond market participants’ approval, or a thumbs-up, if you will, by said participants with the Fed’s rate-cutting actions.
Importantly, it is not only if the line can be penetrated, but also, can it penetrate and move on a trend basis as expected Fed rate cuts unfold. If so, participants will be offering less concern about forward price inflation compared to when the Fed began an ill-advised cutting campaign in latter 2024.
The above underlines our point and gives a visual of what occurred for mortgage rates as the Fed executed their mistimed rate cuts.
Our first red arrow (left) highlights the downtrending behavior of mortgage rates prior to September 2024, which was the beginning of the Fed’s cuts. The Fed’s prior rate-hiking actions along with maintaining rates at a higher level for a period of time had continued to improve the price inflation backdrop.
With this, bond market participants were more comfortable with bidding up bond instruments, which in turn lowered their yields (think interest rate) throughout the interest rate landscape. Their level of comfort changed abruptly with the Fed’s quick turn toward lowering their Fed Funds rate, as we shared in the 10-Year Treasury chart above.
The second red arrow (right) above depicts the abrupt and rapid increase in mortgage rates as the Fed was cutting.
Mortgage rates, like the aforementioned Treasury yield, increased by just over 1%. The level was nearing 5% and quickly went back up to the low 6% area. To belabor the point, this was all while the Fed was cutting interest rates.
With the above, the central point of this edition is to offer that interest rate traders are quickly offering that the Fed will be cutting interest rates as near-term Fed meetings unfold. This offers no certainty that rates across the interest rate landscape, to include mortgage rates, will follow a similar path.
If bond market participants are comfortable with such actions by the Fed, relative to the price inflation landscape, then they can be expected to participate, to X degree, with the Fed’s expected rate cuts.
If price inflation is not cooperating and the Fed still cuts, then we offer, do not be surprised if various interest rates, to include mortgage rates, actually stay elevated or even move higher.
You see, it is all about price inflation, not mandates from X D.C. officials, entities, and departments – to include the Fed.
Clearly, they cannot mandate that price inflation be no more, and with this, bond market participants will not play along unless they are comfortable with the reality of price inflation and their forward views of it.
If they are not comfortable, they will not bid bond prices, and with this, yields (think interest rates) will rise regardless if the Fed is cutting. This is something to think about and to include when assessing news items offering the Fed is about to cut rates. It may not be the guaranteed blessing most assume it to be.
Price inflation and bond market participants are the ultimate inputs in determining how successful Fed cuts can be.
I wish you well...
Ken Reinhart
Director of Market Research & Analysis
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