The bond market is rallying off the Fed's latest rate cut - but that could change come January

MW The bond market is rallying off the Fed's latest rate cut - but that could change come January

By Vivien Lou Chen

The central bank delivered another quarter-point rate cut on Wednesday. Why that decision 'could look reckless' come January, according to one investment manager.

Bond traders appeared to embrace the Federal Reserve's quarter-point interest-rate cut.

U.S. government debt rallied on Thursday, as bond traders appeared to embrace the Federal Reserve's decision yesterday to deliver another interest-rate cut. Still, some investors see reason for caution ahead.

Thursday's bond-market rally sent Treasury yields modestly lower across the curve, on everything from rates on the 1-month T-bill BX:TMUBMUSD01M through the 30-year bond BX:TMUBMUSD30Y. The policy-sensitive 2-year rate BX:TMUBMUSD02Y and benchmark 10-year yield BX:TMUBMUSD10Y each fell by up to 5 basis points, to 3.51% and 4.12%, respectively. Meanwhile, measures of funding-market conditions showed signs that pressures were easing.

The Fed delivered a third interest-rate cut for 2025 on Wednesday, while also announcing plans to inject more liquidity into short-term funding markets. Senior officials penciled in a single rate cut for next year into their forecasts, while futures markets were pricing in two reductions as the most likely outcome, according to CME Group data.

While policymakers said in a prepared statement that they saw risks to both the labor-market and inflation sides of the central bank's dual mandate, the fact remains that the Fed made Wednesday's decision without the benefit of key economic data for October and November, due to the U.S. government shutdown that ended on Nov. 12.

In addition, economists expect the full impact on spending and economic activity from tax cuts under President Trump's One Big Beautiful Bill Act to be felt in 2026. If inflation starts to press higher as a result, Treasury yields would likely start to rise once again.

Fed officials claim "to be 'data-dependent,' yet they just cut rates still not knowing the inflation readings from October or November (due to the government shutdown)," said Andrew Wells, chief investment officer at SanJac Alpha, a Houston-based investment management firm specializing in actively managed fixed-income exchange-traded funds.

If unemployment improves and the missing November inflation data show an acceleration, "this cut could look reckless by January," Wells wrote in an email to MarketWatch.

The bond market's reaction to the Fed's policy announcements on Wednesday stand in contrast to what was seen in October and September, when traders sold off the benchmark 10-year Treasury note on both the day of and the day after the central bank's decisions to cut rates by a quarter-point. The 10-year Treasury yield rose by a total of 11.2 basis points on Oct. 29-30, and advanced by a total of 7.9 basis points on Sept. 17-18.

This time around, the 10-year yield has fallen by a total of 6.4 basis points on Wednesday and Thursday, following the central bank's decision to again drop its fed-funds rate target by a quarter-point increment, to between 3.5% and 3.75%. The Fed's midweek policy announcement also included a forecast for just one rate cut in 2026, and a plan to purchase a total of about $40 billion in Treasury bills, starting on Friday, to inject more liquidity into short-term funding markets.

"The Fed cutting rates while simultaneously indicating its intent to buy $40 billion of T-bills to buoy liquidity in the front end of the bond market could indicate that quantitative easing is on the horizon," said Wells of SanJac Alpha. "This first purchase announcement should ease concerns about liquidity in the front end of the Treasury curve, and we remain bullish on bonds in the [2- to 5-year] tenors."

-Vivien Lou Chen

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December 11, 2025 13:52 ET (18:52 GMT)

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