The Fed Sparked Rally in Corporate Bond ETFs Has Faded, and Analysts Expect No Rate Cuts in 2025, According to These Analysts

The Federal Reserve briefly encouraged risk-taking in financial markets on Wednesday, but that momentum faded on Thursday as investors reassessed its monetary policy stance against concerns over stagflation and potential tariff-related disruptions.

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U.S. stocks closed slightly lower on Thursday, with corporate bonds also facing some selling pressure. The iShares iBoxx $ Investment Grade Corporate Bond ETF declined by 0.2%, while the iShares iBoxx $ High Yield Corporate Bond ETF dropped by 0.1%, based on FactSet data.

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Although markets initially interpreted the Fed’s policy meeting outcome as “dovish,” analysts at CreditSights took a different view, characterizing it as “hawkish.” They suggested that interest rate cuts may not occur as aggressively as traders anticipate.

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The Fed’s summary of economic projections, released alongside its policy statement, indicated that policymakers expect slower economic growth this year compared to previous estimates in December. However, they maintained their forecast for two rate cuts in 2025. At the same time, their projections for inflation and unemployment were revised higher.

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According to CreditSights analysts, the Fed’s decision to leave its policy rate expectations unchanged, despite adjustments in economic forecasts resembling stagflation, reinforced their view that rate cuts are unlikely this year. Elevated inflation levels, they argue, support their expectation that Treasury yields may rise further.

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Corporate bond spreads reflected a degree of optimism following the Fed’s announcement. The extra yield investors demand for holding corporate bonds over comparable Treasurys narrowed on Wednesday, according to CreditSights analysts. Investment-grade bond spreads tightened by two basis points to 0.91 percentage points, while high-yield bond spreads declined by four basis points to 3.19 percentage points, according to data from the Federal Reserve Bank of St. Louis.

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Exchange-traded funds tracking corporate bonds rallied in response to the Fed’s decision. The iShares iBoxx $ Investment Grade Corporate Bond ETF gained 0.6% on Wednesday, while the iShares iBoxx $ High Yield Corporate Bond ETF advanced 0.7%, according to FactSet data.

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The Fed’s widely expected decision to keep its benchmark interest rate steady within the 4.25% to 4.5% range was not a surprise to markets. However, traders reacted positively to the Fed’s announcement that it would slow the pace of quantitative tightening (QT).

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David Mericle, chief U.S. economist at Goldman Sachs, noted in a Wednesday evening report that the timing of this decision was earlier than anticipated, attributing the adjustment to concerns related to the debt limit.

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Quantitative tightening refers to the Fed’s reduction of its balance sheet holdings in debt securities. Chairman Jerome Powell announced that beginning in April, the monthly cap on Treasury redemptions would be reduced from $25 billion to $5 billion. He emphasized that this adjustment would not alter the Fed’s intended monetary policy stance and should not significantly impact the balance sheet in the medium term.

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Powell explained that the Fed had observed signs of increased tightness in money markets but stated that banking system reserves remained “abundant.” CreditSights analysts had expected the Fed to implement a complete pause on QT rather than a gradual reduction.

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Adding to market uncertainty, evolving trade policies from the White House have become another focal point. Powell acknowledged that the overall economic outlook remains highly uncertain in light of changing policies. Reciprocal tariffs are expected to be announced on April 2, contributing to investor concerns.

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There is growing apprehension that tariffs could hinder economic growth and fuel inflation. Powell noted that measuring the exact inflationary impact of tariffs would be challenging, though he suggested that any tariff-driven inflation could be temporary.

In the stock market, major indexes ended lower on Thursday following a decline in Treasury yields. The S&P 500 dipped 0.2%, while the tech-heavy Nasdaq Composite lost 0.3%. The Dow Jones Industrial Average slipped by less than 0.1%, according to FactSet data. This pullback came after all three indexes had posted gains on Wednesday.

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In the bond market, the yield on the 10-year Treasury note fell for a fourth consecutive session, declining 2.4 basis points to 4.233% on Thursday, based on Dow Jones Market Data.

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