We’ve updated our #rate forecasts post-election, based on three main assumptions:
1) The #Fed will continue cutting rates, but may proceed more cautiously and maintain some optionality along the way;
2) The economy will continue to grow around trend near term;
3) A Republican sweep raises the prospects of fiscal expansion, which increases growth and inflation expectations.
We still believe the direction of travel for interest rates is lower as any policy changes will likely take time to be finalized and implemented, the labor market continues to loosen, and the terminal rate has already repriced higher.
But we now see the 10-year US Treasury yield trending towards 4% by June 2025, up from our previous forecast of 3.5%.
Read more below.
What's the bond market signalling here?
Bond markets are often referred to as ''smarter'' than equity markets in predicting what's next for the economy.
Yet the reality is a bit more nuanced.
Today, bond markets are pricing the Fed to proceed with ~175 bps of cuts in the next 12 months hence bringing Fed Funds from 5.25% to 3.50%.
How does one interpret this?
The typical superficial analysis involves looking at these cuts in a simplistic fashion: 175 bps in a year is a robust cutting cycle, so that must mean inflation has collapsed or even a mild recession has hit the US economy.
But what if we think in scenarios?
1) Recession
2) Soft Landing
3) Sticky inflation / Structural ''Higher for Longer''
A more useful way to think about the ~175 bps number is to think of it as the weighted average of scenarios probabilities and Fed actions in each scenario.
1) Recession: 350-400 bps of cuts
2) Soft Landing: 100-200 bps of cuts
3) Sticky inflation / Structural H4L: 0-50 bps of cuts
This is a simple split - you can add more layers too (e.g. deep or shallow recession, etc).
The point is that through the option market you can pinpoint what are the market-implied probabilities for each scenario.
Today, the bond market thinks the following:
- Recession: 20% * 400 bps cuts
- Soft Landing: 50% * 150 bps cuts
- Sticky inflation / Structural H4L: 30% * 25 bps cuts
The weighted average of these probabilities and Fed cuts in each scenario is reflected in that single ~175 bps of cuts you see on the screens.
But a lot more information can be extrapolated by looking at single probabilities and scenarios.
If you are interested in getting regular and granular updates about these probabilistic scenarios and pricing, ping me (Alfonso Peccatiello) on Bloomberg to try out my macro research.
Today we have launched a new forecasting tool for predicting the #yield#curve. We have built a Dynamic Nelson and Siegel model, augmented with daily growth- and inflation-surprises. Based on an evaluation using historical data, the model improves forecast accuracy for the 2-year yield by as much as 24% (compared to consensus). Predictions for the 10-year yield see a smaller but also significant improvement.
The model predicted the current levels of 2- and 10-year Treasury yields — 4.9% and 4.2%, respectively — in June 2022. That was nine months before professional forecasters surveyed by #Bloomberg raised their own predictions for the 2-year rate above 4.5%.
You can find the live #Bloomberg#Economics#Macro-#Yield model as well as survey and contributor forecasts and consensus for US Treasury yields via BECO MODELS<GO> on the #Bloomberg#Terminal!
Andrej SokolJosh DanialScott J.Bhargavi SakthivelAna Beatriz Galvao Martin Ademmer Owen Minde, CFAMike DenicolaAnna Wong
July’s employment report from the Bureau of Labor Statistics should give the Fed the exclamation point they have been looking for to show that the economy is slowing enough to warrant a rate cut. Market expectations have shifted firmly to a 50-bps interest rate cut at the Fed’s meeting in mid-September, rather than a 25-bps cut which had been the prevailing view prior to this report. Now handwringing will ratchet higher as to whether the Fed is in the process of successfully orchestrating a soft landing or if they have waited too long to shift their monetary policy stance.
Job growth slowed more than expected in July and gains in May and June were revised lower. The unemployment rate increased 20 bps during the month and is up 60 bps over the past six months – unemployment rate changes of 50 bps or more over a six-month period have typically corresponded with recessions (see accompanying chart). Wage growth also appears to have slowed over the past couple of months. Even allowing for some volatility in the monthly data, the three-month moving average in employment growth and unemployment show an undeniable softening.
Unemployment insurance claims add further evidence to the slowing trend. Initial unemployment claims have ticked higher over the past three weeks and continuing claims are at their highest level since the fourth quarter of 2021.
It is difficult to call current labor market conditions weak with the unemployment rate still at 4.3%, but job gains appear increasingly lackluster across major employment sectors and the loss of momentum is undeniable. Stock and bond market participants are reacting in a way that suggests increased recession fears. Earnings reports have only fueled these concerns. The 10-year Treasury rate has fallen materially below 4.0%. Mortgage rates have also been ticking lower, which is good news for prospective home buyers.
Rate cuts appear to be on the way, but macroeconomic conditions are increasingly precarious and the Fed’s September meeting may start to feel like a lifetime away if more bad news unfolds. The week ahead is not a busy one from an economic news perspective, but ISM services, mortgage delinquency, Fed Senior Loan Office Survey, and jobless claims, among others will be interesting to watch for additional information on the economy’s trajectory.
What indicators are you watching for?
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To see why rate cuts are coming, look no further than March’s job report. The unemployment rate reached 6.1%, surpassing 6% for the first time in over two years. While Canada added over 300,000 jobs over the past year, the working age population has grown by over a million, resulting an inevitable rise in unemployment rate.
We expect the Bank to hold in April and begin cutting in June as they want another couple of months to solidify the progress made in restoring price stability. If the Bank waits any longer, they risk repeating the mistake made in 2022 of waiting too long, and thus stifling the recovery.
The reality is employers are squeezed by high interest rates and not hiring. This is especially challenging for those entering the labour force for the first time, as youth unemployment rose to 12.6%, the highest since 2016, and many decide to stay out of the labour force altogether. Those who have been laid off also have a hard time finding work.
Businesses expect wage growth to slow in the coming months to match the slow job market, and hiring might pick up in the later half of the year only after rate cuts begin.
The MPC took another step towards rate cuts today with two members voting for a rate cut. What’s more, the minutes included new guidance that “the risks from inflation persistence were receding” and a lower inflation forecast. This lays the groundwork for the first rate cut to come in the summer. We think June is most likely but it wouldn't take much to push it back to August. We then think will be followed by two more cuts leaving interest rates at 4.5% by the end of the year and at least 4 cuts in 2025.
As expected the MPC left bank rate unchanged at 5.2% today. But this was a dovish hold for three reasons. First, Deputy Governor Dave Ramsden joined Swati Dhingra in seeking a reduction in rates making it 7-2. (Ramsden has tended to be a bit ahead of the pack when it comes to changes in direction).
Second, the committee added guidance that it will watch the “forthcoming data releases and how these informed the assessment that the risks from inflation persistence were receding.” We interpret this to mean that as long as there are no big upside surprises in the next few data releases, a rate cut will come sooner rather than later.
Third, the Bank significantly reduced its inflation forecast. If interest rates follow the path that financial markets are now pricing in, inflation would be just 1.6% by the end of 2026 compared to a forecast of 2% made in March. This is a clear message to financial markets that they have gone too far in reigning in expectations for rate cuts.
The upshot is that the Bank is clearly on its way to rate cuts, we think the change in guidance and forecasts are laying the groundwork for the first rate cut to come in summer, probably June but maybe August, it will depend on how the next two inflation and jobs reports turn out. At the very least, every meeting from now on should be considered live.
#RSMUK#RealEconomy#MPC#InterestRates
Do’s & Dots
The Federal Reserve concludes its two-day meeting today, with markets virtually certain that rates will remain unchanged in the 4.25% - 4.50% range—marking the seventh consecutive month at this level. While the rate decision itself holds no surprises, traders are positioning for nuance. Bloomberg reports that savvy investors have taken long positions, anticipating Chair Powell will adopt a more dovish tone that signals future rate cuts. The real risk lies in the updated dot plot projections. A hawkish shift showing fewer anticipated cuts would likely disappoint both Fed watchers and markets, potentially triggering volatility despite the expected rate hold.
Economic fundamentals suggest the Fed will eventually ease policy as growth moderates in the second half of 2025, down from the current 2% pace. The recession narrative has largely faded, with even previously bearish economists revising their outlooks upward. This shift reflects underlying economic resilience that has surprised many forecasters throughout the cycle. For the latter half of 2025, expect GDP growth to decelerate to a more sustainable 1% - 1.5% range—a pace that should provide the Fed with sufficient justification to begin cutting rates without signaling economic distress.
When the Fed does resume its easing path, I expect:
- Treasury rates to decline approximately 50 basis points over that year, with short-term yields leading the decline as the market prices in policy normalization.
- Refinancing activity to accelerate across high-yield and broadly syndicated loan markets as credit spreads tighten and all-in borrowing costs fall.
- Corporate earnings growth to initially slow alongside GDP deceleration, then recover modestly once Fed easing begins to support economic activity.
- M&A activity to rebound significantly as companies that have been hoarding cash and preserving liquidity regain confidence to deploy capital.
- Capital expenditure to increase meaningfully—a long-overdue development that's critically needed.
- Housing market activity to strengthen as lower mortgage rates improve affordability and unlock pent-up demand.
- Financial and technology sectors to outperform given their sensitivity to funding costs.
- Credit market conditions to improve broadly, driving increased demand for private credit while reducing default risks across industry sectors.
While the Fed is likely to remain cautious in cutting rates in the near term, there’s a few reasons to think they could move sooner and more aggressively than most anticipate.
First, as many economists have commented previously, the hiring rate remains very low. This basically means that the labor market is slow to absorb people as they are looking for a job. Research shows that this dynamic is the primary driver of rising unemployment, rather than headline-grabbing layoffs. And as the Fed Chair has previously noted, a low hiring rate can lead to a rapid increase in unemployment – something the Fed is looking to avoid - if the economy begins to sour.
The second reason is that the current trade dynamics coupled with particularly cautious lenders may drive an outsized drawdown in business investment, which increases the potential for a rapid rise in unemployment as mentioned above.
We were already seeing businesses start to cut back on investment in late 2024 given uncertainty over the policy outlook, but I say outsized because:
1) banks entered 2025 still tightening lending standards across all commercial segments – small biz, commercial real estate, etc.
2) banks also entered 2025 with large unrealized losses in their securities portfolios and exposures to underperforming commercial real estate assets. These types of balance sheet challenges reduce the appetite to lend, especially in times of uncertainty.
3) In 2018-2019, in response to trade uncertainty, banks cut back on lending to businesses to reduce their risk. Trade uncertainty is higher now.
And 4) Unlike the consumer market, where the growth in loan delinquency is slowing, business loan delinquency is rising at a high rate – this again increases bank caution to lend.
The third reason why we perhaps should expect a more aggressive Fed is because they have shown their hand before. The Powell Fed in June 2019 forecast no rate cuts for the year as the labor market and economy appeared strong. The very next month the Fed cut rates for the first of three times that year over concerns of anticipated weakness due to the trade disruptions and slowing global growth. While they didn’t have an inflation concern then, they did this past year when the Fed made a surprise, outsized 50bp move in September to support the labor market.
#labormarket#lending#banks#federalreserve
Fixed Income Outlook 2025: What’s Next?
The U.S. fixed income market is at a turning point.
With 10-year Treasury yields at ~4.5%, three forces will shape the future:
Inflation expectations
GDP growth
Term premiums
Nomura’s scenario analysis highlights three possible paths:
1. Recession (10% probability)
GDP shrinks (<0%).
Inflation falls below 1%.
Yields drop to 0-3%.
Weak consumer spending and rising layoffs are key drivers.
2. Soft Landing (60% probability)
Moderate growth (0-2%).
Inflation stays controlled (≤3%).
Yields stabilize at 3-4.5%.
Resilient consumers and gradual Fed easing support this scenario.
3. Trump 2.0 Reflation (30% probability)
GDP grows strongly (>2%).
Inflation exceeds 3%.
Yields rise to 4.5-6%.
Fiscal spending, tariffs, and supply chain disruptions drive inflation higher.
What’s Driving Rates?
Short-term rates respond to policy actions.
Long-term rates depend on growth, inflation, and term premiums.
Higher fiscal deficits or geopolitical risks could push term premiums up.
How Should Investors Respond?
Stay short: Focus on shorter-duration Treasuries for better risk-reward.
Be selective: Investment-grade credits are more resilient.
Think tactically: Structured products offer yield enhancement and risk management.
What’s the Big Picture?
Trump 2.0 policies could reshape markets.
Tariffs and fiscal expansion may fuel inflation.
Portfolio flexibility will be critical in a year full of unknowns.
2025 offers both risks and opportunities. Will you be ready?
#FixedIncome#EconomicTrends#InflationOutlook#InvestmentStrategy#TrumpPolicy#RatesForecast