US Treasury traders reduce rate cut bets as Powell states the Federal Reserve still needs to see progress in controlling inflation

The Federal Reserve has been signaling for months that further rate cuts are far from guaranteed.

On Wednesday, U.S. bond traders finally fully absorbed this message.

After Fed Chair Jerome Powell’s speech, U.S. Treasury prices fell, and short-term yields surged to their highest levels since August. Powell said that policymakers need to see progress on inflation before lowering the target interest rate further. “If we don’t see progress on inflation, we won’t cut rates,” Powell told reporters after the central bank’s second consecutive meeting keeping the target rate unchanged.

On the surface, policymakers maintained their median expectation of one rate cut this year, but ultimately, traders’ judgments were shaped by Powell’s comments. Currently, the rate market shows nearly a 50/50 chance of at least one cut, with the Middle East conflict and soaring oil prices intensifying this heated debate.

The two-year Treasury yield, most sensitive to Fed policy signals, briefly rose 10 basis points to nearly 3.78%, hitting a seven-month high. The 10-year Treasury yield also climbed 7 basis points to 4.27%.

This isn’t the first time markets have adjusted due to Fed signals, but the recent volatility has been particularly intense. Powell noted that the overall trend has “significantly” tilted toward fewer rate cuts, and, as in January, discussions about the possibility of rate hikes have re-emerged.

“If you look at the wording changes over the past six months, you’ll see that the belief in rate cuts has shifted from ‘perhaps’ to ‘we might discuss rate hikes,’” said Robert Tipp, Chief Investment Strategist and Head of Global Bonds at PGIM.

Just three weeks ago, fears about AI disruptions and cracks in the private credit market caused panic in financial markets, with traders expecting the Fed to cut rates three times this year. This anxiety drove U.S. Treasuries to nearly rebound in February, posting their best monthly performance in nearly a year. However, the declines since March have almost erased those gains.

Driven by soaring oil prices, the two-year yield has risen 38 basis points this month, potentially marking the largest monthly increase since October 2024. Currently, the 3.75% yield level has remained above the actual U.S. federal funds rate for several recent trading days—a situation last seen in 2023 when the Fed was raising rates.

The updated Fed dot plot shows policymakers expect one 25-basis-point rate cut in 2026 and 2027, weighing the risks of economic growth and inflation. The additional uncertainty from the Middle East conflict has heightened traders’ concerns that rising energy prices could exacerbate inflation—currently above the Fed’s target—or ultimately suppress economic growth.

Dan Carter, Senior Portfolio Manager at Fort Washington Investment Advisors, said that compared to the negative growth impact from oil shocks, Powell “seems more concerned about inflation.” Carter believes that short- to medium-term Treasury yields are “attractive” because “the likelihood of rate hikes is low.”