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Macro

Bond Traders Eye Fed's 2025 Dot Plot Amid Fewer Rate Cuts, High Inflation

Fed's dot plot update may signal fewer rate cuts in 2024, with traders eyeing 2025 and beyond.

6/10, 16:52 EDT
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Key Takeaway

  • Bond traders are eyeing the Fed's updated dot plot for 2025, anticipating fewer rate cuts due to strong economic data.
  • Current market pricing suggests less than two quarter-point rate cuts this year, with options traders expecting higher rates into 2026.
  • The Fed's policy-rate range remains at a two-decade high of 5.25%-5.5%, with long-term rates potentially rising above the current terminal rate of 2.6%.

Fed Meeting and Dot Plot Update

Bond traders are closely watching this week's Federal Reserve meeting for insights into the central bank's long-term interest rate outlook. The Fed will update its quarterly economic and interest rate projections, known as the dot plot, on Wednesday. In March, officials signaled three quarter-point cuts in 2024, but robust economic data, including strong May jobs growth, may lead them to scale back that forecast. Kevin Flanagan, head of fixed income strategy at WisdomTree, noted, "Maybe we get one or two cuts this year, but how many are we going to get next year?" This sentiment reflects the market's shift in focus toward 2025 and beyond.

The Fed has maintained a policy-rate range of 5.25% to 5.5% since July, with two-year Treasury yields hovering just below 5% and 10-year rates around 4.5%. While the market is pricing in less than two quarter-point rate cuts for this year, recent interest-rate option trades suggest some traders are positioning for rates to stay elevated well into next year and 2026. Options traders are more hawkish than their counterparts in the swaps market, with March 2026 options targeting a Fed rate of roughly 5.75%, compared to swaps indicating a rate around 4% by that time.

Inflation and Economic Resilience

A fresh read on inflation, expected just hours before the Fed concludes its meeting, will likely show prices running well ahead of the central bank's comfort zone. This data gives the Fed little leeway to cut rates soon, leading investors to debate whether future easing will be limited to minor policy tweaks rather than the series of reductions many had anticipated. Jean Boivin, head of the BlackRock Investment Institute, cautioned that the bond market should be wary of expecting a delayed easing cycle, given the likelihood that inflation will average above the Fed's 2% target. "The bond market faces the prospect of adjusting to the realization that this is a shallow cutting cycle," Boivin said.

The March dot plot projected the Fed's policy benchmark to drop to 4.6% by December and to 3.9% by the end of 2025. However, only a narrow majority of officials signaled they expected to cut rates three times this year, with nearly half preferring two or fewer reductions in 2024. David Robin, a strategist at TJM Institutional, emphasized, "It’s the dots that matter. It’s either two moves or lower. And we would not at all be surprised to see at least two or three dots move to one or none for 2024."

Market Reactions and Investment Strategies

The resilience of the economy and loose financial conditions, despite a 5% plus Fed funds rate, have spurred discussions about whether policy is truly restrictive and may need to rise. Priya Misra, portfolio manager at J.P. Morgan Asset Management, noted, "The debate on whether policy is restrictive or not will continue as the data is mixed on the whole." She expects the FOMC to signal a median of two cuts for 2024 and three cuts in 2025, with Fed Chair Jerome Powell likely to emphasize that the dots are not a forecast but a function of the data.

Mark Dowding, chief investment officer at RBC BlueBay Asset Management, is focused on the Fed’s terminal rate, which he believes is too low at 2.6%. "We’re now in a world where inflation continues to overshoot," Dowding said, suggesting that the long-run dot could shift toward 2.75% on a "journey somewhere north of 3%." This outlook leads him to advocate caution over longer-dated Treasuries due to high debt levels in the US. Instead, he favors a steepener trade, where short-term yields decline faster than those on longer-term debt, although this positioning has not been successful recently.

Kristina Hooper, chief global market strategist at Invesco, anticipates a "more gradual" rate-cut cycle that will support an environment for risk assets and a re-acceleration in economic growth. "Every day that goes by that the Fed doesn’t cut there’s a psychological and a real impact to the economy," Hooper said, adding that the US economy has shown resilience.

Street Views

  • Kevin Flanagan, WisdomTree (Neutral on Fed policy):

    "We’re going to quickly turn the page to 2025. Maybe we get one or two cuts this year, but how many are we going to get next year? That will quickly become the center of attention as we move into the second half of this year."

  • Jean Boivin, BlackRock Investment Institute (Bearish on bond market expectations):

    "The bond market should be wary of anticipating that a delayed easing cycle will finally arrive given the likelihood that inflation averages above the Fed’s 2% target... The bond market faces the prospect of adjusting to the realization that this is a shallow cutting cycle."

  • David Robin, TJM Institutional (Neutral on Fed rate outlook):

    "It’s either two moves or lower. And we would not at all be surprised to see at least two or three dots move to one or none for 2024."

  • Priya Misra, J.P. Morgan Asset Management (Cautiously Optimistic on economic data and Fed signals):

    "There is strong labor supply but consumer confidence and hiring intentions from small business is weakening... She expects the FOMC to signal a median of two cuts for 2024 and three cuts in 2025, with chair Powell emphasizing that 'the dots are not a forecast but a function of the data.'"

  • Mark Dowding, RBC BlueBay Asset Management (Bearish on long-term Treasuries):

    "We’re now in a world where inflation continues to overshoot... A market aligned closer to the Fed’s expectations for the rate path leaves Dowding advocating caution over longer-dated Treasuries largely because of debt levels in the US."
    "[He] favors a so-called steepener trade — where short-term yields decline faster than those on longer-term debt — although that positioning has failed to work lately. Eventually we think chickens will come home to roost there and you’ll see some steepening of curve."

  • Kristina Hooper, Invesco (Bullish on risk assets and economic growth):

    "[She] doesn’t anticipate a very aggressive rate-cut cycle. Instead she sees 'a more gradual' pace that will support an environment for risk assets and reacceleration in economic growth."
    "'Every day that goes by that [the] Fed doesn’t cut there’s psychological and real impact [on economy]. Having said though I do think US economy has been resilient.'"