Neutral interest rate or additional cut... Disagreement in the US Treasury market over the 2026 interest rate path

Source: BlockMedia Original Title: ‘Neutral Rate’ or ‘Additional Cut’… Dispute in US Treasury Market Over 2026 Rate Path Original Link: The US bond market, which迎来了 the end of 2025, is once again experiencing turbulence. As the Federal Reserve(Fed) has cut interest rates three times this year, a subtle gap between the market and the Fed over the possibility of further cuts next year is becoming more apparent. Meanwhile, key economic indicators such as employment and inflation scheduled to be released this week are expected to serve as an important turning point in gauging the future direction of monetary policy.

Market anticipates ‘two cuts’… Fed remains cautious

The November employment report and key economic indicators like the Consumer Price Index(CPI), delayed by the government shutdown, will be released sequentially starting this week. In particular, employment data released ahead of the Federal Open Market Committee(FOMC) meeting scheduled for late January are expected to play a pivotal role in narrowing the gap between the market and the Fed regarding the pace of future rate cuts.

George Cartrambon, Head of Bond Markets at DWS Americas, said, “The direction of employment will determine the rate path next year,” adding, “The employment report to be released this week could serve as a ‘catalyst for a policy revision’ for the Fed.”

Currently, the bond market has already priced in two rate cuts in(2026). This exceeds the number of cuts hinted at by the Fed. If these market expectations materialize, US Treasuries could achieve their best performance since 2020.

In fact, the policy-sensitive 2-year US Treasury yield is trading around 3.5%, and the 10-year yield is around 4.2%. Last week, yields declined after Chair Powell mentioned concerns about a slowdown in the labor market following a 0.25 percentage point rate cut.

Options markets are also rapidly building positions reflecting possible rate cuts in the first quarter of next year. However, currently, the first cut is priced in for June, with a second in October.

Caution in interpreting employment indicators… “Actual direction depends on January data”

The event attracting the most market attention now is the November employment report. Expected to be released on December 16(local time), the report is forecasted to show an increase of around 50,000 jobs, significantly lower than the 119,000 jobs added in September. The September unemployment rate was 4.4%, the highest since the pandemic.

Bloomberg market strategist Ed Harrison said, “The employment data released this week will be the next test for a rebound in Treasuries,” adding, “If the figures fall short of expectations, the timing of rate cuts could be moved up from June to April.”

However, due to data collection constraints caused by the shutdown, some caution in interpreting employment data is advised. Kevin Flannagan, CEO of WisdomTree Bonds, stated, “Next January’s employment figures are more important than this release,” and “For additional cuts at the January FOMC, clear signals of a labor market slowdown are necessary.”

He further explained, “If employment remains solid, interest rates could rebound again,” and “If job gains confirm around 110,000, the 10-year Treasury yield could rise to 4.25%.”

Debate over the neutral rate… Fed Chair change also a variable

Recently, discussions have emerged over whether the Fed’s current interest rate has reached the neutral rate. Fed Chair Powell stated, “Current rates are within the broad estimates of the neutral rate.” The market expects this rate-cutting cycle to end around 3.2%. Accordingly, there is an outlook that the bond market could continue a limited, income-focused flow into next year.

Within the Fed, there are differing views on rate cuts. Chicago Fed President Charles Evans said, “We need to see more inflation indicators,” signaling a cautious stance on rate reductions.

The possibility of a change in the Fed chair also remains a key variable. Powell’s term runs until May 2026, and President Donald Trump is currently in the process of selecting his successor. Janette Relling, Head of Global Bond Portfolio Management at Aolspring, commented, “The greater the influence of President Trump, the more likely the Fed’s policy stance will adopt a dovish tilt.”

This week, releases include the Empire Manufacturing Index on the 15th, employment, retail sales, and S&P PMI on the 16th, CPI and real wages on the 18th, and existing home sales and consumer confidence indices on the 19th. The future direction of the Fed’s rate policy in 2026 will be shaped by these indicators.