Investor sentiment shifted significantly this week as traders raised their expectations for the Federal Reserve to cut interest rates in 2025, with some even anticipating a potential rate cut before the Fed’s next scheduled policy meeting. This sharp adjustment in outlook comes as the U.S. administration’s renewed tariff policies spark worries of a global economic downturn.
At one point, markets briefly priced in a total of 125 basis points worth of rate cuts by the end of the year — which would be equivalent to five quarter-point reductions — according to overnight interest rate swaps. Though those expectations eased somewhat later, the shift was striking. Just last week, traders had fully priced in only three rate cuts. Now, the probability of the Fed making a 25-basis-point cut as early as next week — ahead of its May 7 meeting — has climbed to nearly 40%.
This sudden repricing highlights the fear sweeping across financial markets, driven largely by President Donald Trump’s firm stance on implementing broad import tariffs. Trump, speaking to reporters on Sunday, suggested that market reactions should be ignored, saying, “forget markets for a second,” signaling that trade tensions may continue for some time.
As a result, investors rushed to safer assets. On Monday, the yield on the two-year U.S. Treasury note — often viewed as a key gauge of monetary policy expectations — dropped as much as 22 basis points to 3.43%. Although some of that decline was reversed later in the day, it reflected the initial panic that gripped the market.
Daniel Loughney, head of fixed income at Mediolanum International Funds Ltd., noted that his team is closely monitoring the evolving situation. “At this point, it’s a matter of whether we take profits or stay in,” he said. “The markets are still structurally sound, but if Trump sticks with his aggressive approach, we may be in for more turbulence.”
Historically, emergency interest rate cuts by the Fed are rare. The last instance occurred in early 2020 at the onset of the COVID-19 pandemic. Although traders also briefly priced in an emergency cut last August during a sharp stock selloff, the Fed opted not to act. Now, once again, speculation about an inter-meeting cut is building, especially as volatility increases.
Open interest in the April fed funds futures contract soared last week, with Thursday’s volume hitting a record high. One notable block trade appears positioned to benefit if the Fed moves to adjust its benchmark rate before the scheduled May meeting, based on the contract’s expiry timeline.
The ripple effects of this turmoil were felt beyond the U.S. as well. On Monday, German government bonds rallied, with the yield on the German two-year bond falling by as much as 20 basis points to just above 1.60%. This marks its lowest level since October 2022, although part of the drop was later retraced.
Fears of a U.S. recession are also gaining traction. Economists at JPMorgan Chase now expect the U.S. economy to tip into recession this year. Chief Economist Michael Feroli predicts the Fed will begin cutting rates in June and continue doing so at each meeting through January 2026. JPMorgan CEO Jamie Dimon also urged swift resolution to the uncertainty created by the trade tensions.
Last week, Goldman Sachs economists revised their forecast as well. They now expect the Federal Reserve and the European Central Bank to each implement three rate cuts this year. Meanwhile, governments around the globe are scrambling to engage with U.S. officials to mitigate the impact of the newly imposed tariffs. This frantic diplomatic activity is adding to market volatility, as traders attempt to price in the possibility — or failure — of international trade deals.
The ripple effect of these developments is being felt across other central banks too. Traders have ramped up bets that both the ECB and the Bank of England will be forced to cut interest rates to shield their economies. Swaps now indicate expectations of three quarter-point cuts from each bank, with nearly a 50% chance of a fourth reduction by year-end.
Despite these mounting pressures, Federal Reserve Chair Jerome Powell made it clear in remarks last Friday that the central bank would be cautious in responding. He emphasized that inflation remains elevated and that any response to recent market disruptions would need to be measured, especially given the temporary price spikes that tariffs can cause.
Economist Lou Crandall from Wrightson ICAP noted that while a rate cut before May 7 is possible, the likelihood remains under 50%. He warned that a premature rate move could backfire if it’s perceived as a reaction to crisis rather than a calculated decision. “A preemptive cut only works if it boosts business confidence. If it appears like a panic response, it could do more harm than good,” he said.
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