Market expectations for Federal Reserve interest rates have undergone a dramatic reversal, with short-term Treasury yields becoming unanchored against a backdrop of surging oil prices. Data from federal funds futures now indicate a 35% probability that the benchmark interest rate will be raised by at least 25 basis points following the October Federal Open Market Committee (FOMC) meeting. This marks a sharp shift from just one month ago, when markets were pricing in a 35% chance of a 50-basis-point rate cut.
The yield on the two-year Treasury note has climbed back above 3.9%, reaching its highest level since July. This recovery has completely erased the steep decline seen at the front end of the yield curve in July, which was triggered by weak employment data and had initiated a seven-month steady downtrend. The recent rebound has occurred since the attack on Iran.
Seth Golden, Chief Market Strategist at Finom Group, noted that, similar to what was observed in 2022, the two-year Treasury yield has decoupled from the federal funds rate, and the futures market is increasing bets on a rate hike before the end of the year. He stated, "In 2022, one could argue that rate hikes did not impact the consumer economy, which was—and still is—buffered by fiscal dominance in the form of government transfer payments and tax legislation." He added that potential Fed Chair nominee Kevin Warsh "might advocate for using other tools within the Fed's toolkit to address reflation risks," rather than relying solely on interest rate adjustments.
Concurrently, Christian Fromhertz of Tribeca Trade Group pointed out that the MOVE Index, often referred to as the "VIX for bonds," is experiencing a significant surge. A rising MOVE Index reflects increased uncertainty about the future path of interest rates. Historically, such spikes have often preceded broader market volatility, making their implications more pronounced. Sharp movements in the MOVE Index can be viewed as a potential early warning signal for future spikes in the VIX fear gauge and subsequent declines in the stock market.
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