Is the market just chasing shadows? Most economists predict that the Federal Reserve will not cut interest rates this year, so the pricing of bond market rate hikes is purely an overreaction.

Due to the impact of energy prices and fluctuating inflation, expectations for a rate cut by the Federal Reserve have significantly cooled off this year. According to a recent survey, most economists believe that the Fed will avoid cutting rates this year and postpone rate cuts until next year. Respondents generally believe that the inflation triggered by the conflict with Iran is "temporary." Since December last year, the federal funds rate has been maintained in the range of 3.50%-3.75%. Currently, less than half of economists expect a rate cut this year, contrasting sharply with over two-thirds of people last month who expected at least one rate cut. However, economists' overall outlook on interest rates remains moderate, continuing to believe that the inflation triggered by the surge in energy prices since the Iran conflict two and a half months ago is temporary and unlikely to spread more broadly to other consumer prices. In a survey conducted from May 14th to 19th of 101 economists, nearly 85% (83 people) expect the benchmark rate to remain unchanged in the range of 3.50%-3.75% until the third quarter. In contrast, last month this proportion was slightly above half, and in March nearly 70% of people expected at least one rate cut by then. Aditya Bhave, chief U.S. economist at Bank of America, said, "Both a rate hike and a rate cut are possible... The base case is to keep rates unchanged, frankly, the difference between the other two options is very small. It feels like if the next move by the Fed is a rate cut, it is more likely to happen next year than this year." But he added, "There is indeed upside risk to inflation... We are not geopolitical experts, nor are we commodity forecasters. There is obviously a lot of uncertainty in our forecasts." At the Fed's April meeting, three policymakers dissented, advocating for removing dovish language from the policy statement, while another voted in support of an immediate rate cut. Since then, Fed officials have consistently advocated for a wait-and-see approach, citing the uncertainty related to the ongoing conflict with Iran. However, economists believe that incoming Fed chairman Kevin Warsh is unlikely to fulfill President Trump's desired rate cut. As for the year-end interest rate level, economists have not yet reached a clear consensus, but close to half (49 out of 101) expect no adjustments this year, a proportion higher than the previous approximately one-third. Nearly a third of people expect a rate cut this year, with the majority expecting it in December. Four economists expect at least one rate hike. Bond market rate hike bets are considered "overreacting" In sharp contrast to economists' expectations, the bond market has at one point priced in a rate hike by the Fed this year. Stimulated by inflation data, the yield on 30-year U.S. Treasury bonds has surpassed 5%, the yield on 10-year bonds briefly rose above 4.6% to a 15-month high, and 2-year yields also hit a new high. Federal funds rate futures at one point pushed the probability of a rate hike to about 50%, with some contracts even pricing in a rate hike of 25 basis points by December or the end of January next year. Regarding this market trend, many strategists have expressed doubts, believing that there is a clear "overreaction" at the moment, with core questions arising from the thin trading volume of forward rate contracts. Will Compernolle, macro strategist at FHN Financial, pointed out that liquidity in longer-dated contracts is extremely poor, citing the example of the May 2026 contract trading about three times more than the January 2027 contract this month, with trading for more distant contracts sometimes only in the thousands of times. "This is a low-confidence signal, the market may just be hedging against potential rate hike risks." Ryan Swift, chief U.S. bond strategist at BCA Research, also said that financial markets process information much faster than the evolution of actual data, sometimes capturing correct signals in advance, but "more often than not, it's an overreaction." Inflation expectations have risen, but are still seen as a temporary phenomenon In the view of economists, inflation remains the biggest variable. Currently, the U.S. inflation rate is more than 1 percentage point above the Fed's 2% target and has been above that level for over five years. The Fed's preferred inflation measure - the Personal Consumption Expenditures (PCE) Index - is currently at an annual rate of 3.5%, the highest since May 2023. Economists currently expect the index's year-over-year growth rates to reach 3.9%, 3.7%, and 3.4% in the second, third, and fourth quarters, respectively, about 25 basis points higher than last month's forecast, marking the third consecutive raise in expectations. In a smaller sample survey, nearly 86% of respondents believe that the current inflation pressure is temporary, but there is a divergence on whether this situation will change. Scott Anderson, chief U.S. economist at BMO Capital Markets, said, "As economists, our recent track record on inflation forecasts hasn't been good. We may be entering a new era where we will face shocks more frequently, which is a significant risk." Additionally, economists' expectations for the unemployment rate and economic growth rate remain largely unchanged, forecasting an average unemployment rate of 4.3% or slightly higher in the coming years (close to the current level) and an average economic growth rate of about 2%.