Bond Traders Push Back Against Fed's Rate Hikes, Triggering Market Ripples

A growing number of bond traders are betting against the Federal Reserve’s continued stance of maintaining elevated interest rates, causing a notable divergence in market pricing. The two-year Treasury yield, which typically moves in tandem with Fed funds expectations, has dropped 15 basis points since early November, now trading at 4.87%, despite the Fed signaling no immediate rate cuts in its December meeting. This trend suggests traders are pricing in a faster path to rate reductions than the central bank’s guidance implies. The 10-year Treasury yield has also declined by 12 basis points over the same period, settling at 4.42%, reflecting increased demand for longer-duration debt. Market-implied probability of a rate cut by mid-2026 has risen to 68%, up from 52% in late November, according to swap data. This shift has prompted a widespread reassessment by institutional investors and hedge funds, with several large fixed-income portfolios adjusting duration exposure in anticipation of a dovish pivot. The divergence has intensified debate among Wall Street firms. While some analysts at major investment banks continue to align with the Fed’s data-dependent approach, others warn that bond market pricing is factoring in weaker economic momentum, particularly in labor and consumer spending data released in November. The unemployment rate rose to 4.3% in November, the highest in over two years, while retail sales growth slowed to 0.2% month-over-month. The implications extend beyond Treasury markets. Yields on investment-grade corporate bonds have compressed by 8–10 basis points, boosting equity valuations in rate-sensitive sectors such as real estate and utilities. Meanwhile, the yield curve has flattened further, with the 2s10s spread narrowing to 45 basis points—its tightest level since early 2023—raising concerns about a potential inversion and recessionary signals.