After news of China’s retaliation, traders raised rate cut expectations to 116 basis points by the year’s end, suggesting over a 50% likelihood of a fifth cut. This reflects market speculation regarding a possible conclusion to the trade war or support from the Federal Reserve.
Should conditions deteriorate without intervention from the central bank, expectations for more aggressive cuts may grow. The longer the Fed stays inactive, the more likely the market will anticipate larger reductions to address a potential economic downturn.
Geopolitical Impact on Market Sentiment
The current projection for 116 basis points in reductions by the end of the year demonstrates just how swiftly sentiment can shift in response to geopolitical shocks. Market participants appear to be positioning around the idea that external pressures — such as tariff escalations or retaliatory policies — may prompt monetary authorities to act more decisively than previously anticipated. The increase in basis point cuts now priced in reflects this adjustment in expectations, as well as a growing conviction that policymakers may not wait for traditional indicators to deteriorate further.
Powell’s recent inaction has drawn attention, especially when short-term rates continue to price in more acceleration. That gap between the market’s expectations and the central bank’s stance can’t persist without volatility intensifying. If the committee delays too long, it risks finding itself behind the curve — which is historically when decisions have had to be bolder than initially necessary.
What we are watching closely now are the front-end interest rate futures, since those respond most sharply to shifts in policy tone. The weight of implied cuts being continually repriced higher tells us how aggressively traders are hedging against further economic weakness. It also signals a market that is no longer confident in a soft landing scenario, especially if trade tensions worsen from here.
Yields on short-dated Treasuries have fallen in lockstep with these expectations, lending further support to steepening trades. The pressure is currently building around the two-year note, which has moved lower in yield more quickly than any time since early 2020. This kind of curve reaction tends to precede a rate cycle shift — not confirm it — which makes the next set of economic prints even more influential.
Market Volatility and Policy Implications
Daly’s moderate comments last week offered some support to a more cautious approach, but when futures markets shift nearly half a point in a matter of days, it pays to reassess positioning beyond headline sensitivity. This is where we come in — reading between the lines of official statements while staying nimble in shorter-duration exposures. Option volatility remains well bid, particularly in the belly of the curve, suggesting traders are expecting larger intraday or week-on-week swings.
We should be cautious not to interpret this as a full policy pivot quite yet, but the magnitude of implied cuts now priced indicates markets are giving up on hawkish hold scenarios. Reaction to headline CPI and payrolls reports will remain central to how pricing adjusts from here. Volumes are also starting to build in eurodollar contracts several quarters out, which typically points to growing sentiment around liquidity provisioning.
Bullard’s absence from public comments this week creates some space for the more dovish voices on the committee to shape the narrative. If core inflation moderates soon — which current swaps are starting to lean towards — then holding short gamma could be inadvisable. The risk/reward currently favours owning volatility, especially on dates straddling policy meetings or major data releases.
In terms of actionable response, staying light on directional conviction until policy signals become clearer tends to limit drawdown. We’ve shifted to maintaining neutral delta exposure with tactical long gamma in risk-off scenarios. Where the bias exists, it remains against tighter policy for the remainder of the quarter unless economic data forces that recalibration sooner than expected.
