The Fed has cut rates. What happens to the yield curve from here?

After the Federal Reserve’s 50 basis point rate cut, the most notable market reaction to the rate cut has been a steeper yield curve, driven by shifts at the front end, analysts said Thursday.

Inflation expectations have slightly risen, as reflected in the 10-year inflation breakeven rate. While overall market rates initially moved lower following the rate cut, longer-end rates ended the day slightly higher.

ING notes that the curve steepening is likely to continue, with the 10-year Treasury yield constrained by its spread to the 10-year SOFR, currently about 45 basis points.

The bank expects this to persist, with a potential for further upward pressure on longer-term rates, despite the Fed’s easing. They emphasize that the Fed’s current stance, which remains relatively bullish on the economy, is not focused on preventing a sharp slowdown.

“[Powell] just sees the risks as being balanced between inflation and the labour market,” ING’s note states. “The Fed is not fearing a recession, and will only cut to ease restrictive policy.”

This has led to ongoing supply pressure in Treasuries, further limiting the room for long rates to decline.

Powell downplayed the possibility of further 50 basis point cuts, stating that the Fed is not in a rush to lower rates further.

Analysts at Bank of America describe the Wednesday move as a “hawkish cut,” with the Fed signaling that future rate reductions will likely come in smaller increments, around 25 basis points in upcoming meetings.

The yield curve steepened after the announcement as long-term yields have risen in response to higher demand for duration and lower forex (FX) hedging costs for foreign investors. The steepening reflects the market’s confidence in the Fed’s ability to manage inflation while supporting growth.

Moreover, BofA notes that the market is currently pricing in slightly more cuts than the Fed’s own projections suggest, which could lead to further adjustments in the yield curve going forward.