Trump returns to the White House, and everyone expects him to engage in fiscal expansion, which would squeeze the Federal Reserve's future space for interest rate cuts.
The Federal Reserve just cut rates by 25 basis points last Friday, and previously made a significant cut of 50 basis points in September. Now, the market is less optimistic about further rate cuts. Everyone believes that with Trump's tax cuts and tariffs, economic growth will accelerate, and consumers will also see increases. The Federal Reserve will have to worry if it significantly cuts rates next year and inflation rebounds, what will happen then?
The main focus of the election is to slow down the pace at which the Federal Reserve lowers interest rates. They now expect that the number and magnitude of interest rate cuts by the Federal Reserve in 2025 will decrease.
Since mid-September, U.S. Treasury yields have skyrocketed by more than 70 basis points, recently reaching the largest single-month increase since the 2008 financial crisis. This increase closely aligns with Trump's rising support in polls and betting markets in October.
Investors now expect that interest rates will drop from the current 4.5%-4.75% to about 3.7% by the end of next year. Bank strategists have also raised their short-term targets for Treasury yields.
Powell remains quite calm, stating that the rise in yields is due to improved economic prospects, not rising inflation expectations. This week, inflation expectations measured by Treasury Inflation-Protected Securities have surged. The 10-year breakeven inflation rate has risen to 2.4%.
A rebound in inflation could force the Federal Reserve to slow down or pause interest rate cuts.
Andrzej Skiba from Royal Bank of Canada said he is preparing for further selling of long-term bonds. He mentioned that if tariff policies are implemented as expected, it will be difficult for the Federal Reserve to cut rates.
Rick Rieder from BlackRock stated that if the Federal Reserve makes significant cuts in 2025, it would be like "giving money to the market." He also noted that bonds as an income-generating asset are currently more attractive than as an asset betting on rate cuts.
