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February 6, 2025

The Shifting Landscape of Interest Rates: What’s Next for Investors?

In the ever-changing world of finance, it’s not uncommon for market expectations to shift dramatically in a short period. Just a few months ago, in September, the market was pricing in an aggressive cutting cycle, with multiple 50-basis point cuts expected to bring the fed funds rate down to 3% by 2025. Fast forward to today, and the narrative has changed significantly, with only one to two cuts now priced in for 2025.

Understanding the Change in Market Sentiment

So, what’s driving this change in market expectations? To answer this, let’s take a closer look at the effective federal funds rate (EFFR) and the two-year Treasury note. The chart below compares these two yields, providing valuable insights into the market’s expectations.

[Insert chart]

By analyzing this chart, we can identify a few key takeaways:

* Throughout the last two years, the two-year Treasury note has often priced in an imminent and aggressive cutting cycle, as seen when it falls below the EFFR.
* For the first time since mid-2022, the two yields are now at parity, indicating that the market is pricing in a rate-cutting cycle that is essentially over, with no chance of hikes.

The Role of Inflation and the Labor Market

So, what’s behind this shift in market sentiment? One major driver is the surprisingly stubborn inflation. As seen in the December summary of economic projections, FOMC members have aggressively shifted their stance on inflation, now seeing risks weighted to the upside.

This, combined with a more resilient labor market than initially anticipated, is shifting the distribution of probable outcomes towards a hawkish monetary reaction function. In other words, the market is now expecting a more cautious approach from the Federal Reserve, with a greater emphasis on controlling inflation.

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Dovish Voices Within the FOMC

While the market is pricing in a more hawkish approach, there are still dovish voices within the FOMC. Governor Waller, in his recent speech, expressed his support for continuing to cut the policy rate in 2025, citing the need to balance inflation with labor market growth.

Navigating the Extremes of 2025

As we head into 2025, it’s clear that investors will need to be prepared for another year of extremes. The market is likely to continue pricing in aggressive hawkishness and dovishness, making it challenging for investors to navigate.

So, what’s the best approach? Should investors try to ride these changes in sentiment, or ignore them as noise? The answer will depend on individual investment strategies and risk tolerance. However, one thing is certain – staying informed and adaptable will be key to success in the ever-changing world of finance.

Conclusion

In conclusion, the landscape of interest rates is shifting, and investors need to be prepared. By understanding the drivers behind this change, including inflation and the labor market, investors can make more informed decisions. While there are still dovish voices within the FOMC, the market is pricing in a more hawkish approach. As we head into 2025, investors will need to navigate the extremes of market sentiment, staying informed and adaptable to succeed.

Source: Bitrss.com

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