On December 16, the U.S. Treasury market showed mixed results as investors adopted a wait-and-see approach ahead of this week's Federal Reserve rate decision. The market widely expects a 25 basis point rate cut by the Federal Reserve, but the tone may lean hawkish, suggesting a slowdown in future rate cuts, or even a possible reduction in easing by 2025.
"Hawkish Rate Cut" May Become Policy Tone
The two-day meeting of the Federal Reserve this week is highly anticipated. The market expects the Federal Reserve to lower the benchmark interest rate by 25 basis points to the range of 4.25%–4.50% during this meeting, but the real focus is on the Federal Reserve's guidance regarding the future rate path.
Institutions like BNP Paribas believe the Federal Reserve may maintain stable rates next year, postponing further cuts until mid-2026. Former Cleveland Fed President Mester also suggested the need to reassess the previously forecast four rate cuts in 2024, considering "two to three cuts more appropriate."
Additionally, Goldman Sachs analysts propose that the Federal Reserve might signal a slowdown in rate cuts this week and expect to "skip" a rate cut in January. This view aligns with data from the CME FedWatch Tool, which indicates only a 14.7% probability of further rate cuts by the Federal Reserve in January.
The internal stance of the Federal Reserve is also gradually emerging. Nick Timiraos, known as the "New Fed Whisperer," pointed out that in this meeting, the Federal Reserve might cut rates by 25 basis points and, through new economic forecasts and statements, emphasize slowing the pace of easing, relying on specific economic data for future decisions.
U.S. Treasury Market Anticipates Policy Outlook, Adjusts Maturity Preferences
The recent fluctuations in the U.S. Treasury market have preemptively reacted to the Federal Reserve's policy outlook. Unlike the past year when investors favored purchasing long-term Treasuries in anticipation of falling interest rates, recent funds have shifted away from long-term Treasuries, focusing instead on two- to five-year medium to short-term Treasuries.
Jay Barry, Head of Global Rates Strategy at JP Morgan, noted that investors expect this easing cycle to be relatively mild, "No one is willing to significantly extend duration." Data from the U.S. Commodity Futures Trading Commission (CFTC) shows that asset management companies have recently reduced their net long positions in long-term Treasury futures, while leveraged funds have increased their net short positions in long-term Treasuries.
This shift occurs against the backdrop of a significant jump in the yield of the U.S. 10-year Treasury by 24 basis points last week, marking the largest weekly increase this year. Concerns about future elevated interest rates have led investors to demand a risk premium for holding long-term Treasuries, thereby increasing long-end Treasury yields.
Behind the Hawkish Tone: Policy and Political Expectations
The market's "hawkish rate cut" expectation is not unfounded. As the U.S. 2024 election approaches, concerns about potential policy changes by a Trump administration—such as inflation spikes and intensified trade tariff policies—are deepening. Some institutions predict that the Federal Reserve's tightening stance will align with potential economic stimulus policies from a new government, moderately slowing the pace of rate cuts.
Market Cautiously Observes
This week's Federal Reserve policy statement and Chairman Powell's remarks will be key indicators for market movements. If the Federal Reserve sends out a clearer signal of slowing easing, the market might reprice the future rate path, further driving fluctuations in Treasury yields and the dollar.
In this context, investors need to closely monitor the Federal Reserve's latest economic forecasts and market reactions, particularly the shifts in maturity preferences between short-term and long-end Treasuries.
