Rate Hike or Rate Cut? The Fed is pushing the market into “split personality”

Interest rate futures are pricing in a Fed rate hike in early autumn, but Citigroup expects a rate cut in October. Bank of America even calls for three rate hikes in the year. Strategists warn that, with the official expectation “anchor” removed, the market will have to gamble—50-50—on whether each Federal Reserve meeting results in a rate hike or a rate cut.

The difficulty of forecasting the Fed’s policy has increased dramatically, and opinions on Wall Street have become sharply divided.

Trading in interest rate futures shows that the Fed is expected to raise rates at least once in early autumn this year, and then raise them again next year. However, many asset management institutions hold the opposite view. They believe that, with international oil prices falling and the labor market weakening gradually in the second half of 2026, inflation pressure will naturally ease. The Fed will most likely keep interest rates unchanged, and may even start a rate-cutting cycle.

Byron Anderson, Head of Fixed Income at Laffert Tengler Investments, said bluntly: “The market’s bets on rate hikes are too aggressive, overestimating how persistently oil price increases will transmit to food and all categories of goods.”

In his view, the core driver of the upward inflation pressure in this round is energy-price disruption. Once crude oil supply returns to normal, pricing pressure from higher prices will quickly fade. Combined with slowing wage growth and a cooling housing market, deflationary forces are set to regain the upper hand in the coming months, and the Fed has no need to hike rates at all.

Federal Reserve Chair Kevin Warsh previously issued a series of hawkish signals, directly reshaping the yield curve of U.S. Treasuries. The spread between short- and long-end yields has continued to narrow, and the curve has flattened significantly—fully reversing the market’s trading logic of curve steepening that had been priced in ahead of Warsh taking office at the end of May.

Behind the flattening of the curve is market consensus: inflation stickiness will be difficult to fade quickly, the Fed will not cut rates in the near term, and there is even a possibility of another rate hike.

Chip Hughey, Managing Director of Fixed Income at Truist Wealth, interpreted the curve signals, saying: “The yield curve fully reflects Warsh’s firm stance to push inflation down to the 2% long-term target. Short-term yields will remain at current elevated levels for longer.”

Divergence in rate expectations across major investment banks has reached an extreme. Citigroup expects the Fed’s next move will be a rate cut, with the earliest possible cut as soon as October, down by 25 basis points. Bank of America, by contrast, forecasts three cumulative 25 basis point rate hikes over the full year.

Institutions say that this split in expectations will deeply affect the trading logic for U.S. Treasuries. The warming of rate-hike expectations has already directly pushed up short-term Treasury yields. If the Fed remains on hold for the long term and only starts cutting rates in the distant future, medium- and long-dated Treasuries will face opportunities for valuation repair.

Historical patterns in rate-cutting cycles show that in the initial stage when rate cuts land, short-term yields fall first. Money will actively extend duration to lock in high yields. In a rate-cut environment, long-duration Treasuries consistently outperform short-duration Treasuries.

After the shock from the Fed’s hawkish remarks last week, bond investors have generally shifted toward neutral positioning. The latest JPMorgan survey of Treasury clients shows the share of neutral positions among active trading clients has risen to 56%, the highest since the end of March.

Maintaining a neutral stance means matching the portfolio’s duration to that of the benchmark. For example, if the benchmark duration is five years, a neutral strategy should hold fixed-income securities with a duration of five years or close to five years.

Lori Heinel, Global Chief Investment Officer at State Street Investment Management, leans toward the rate-cut logic, forecasting that the Fed will begin cutting rates in early 2027 and keep rates unchanged during the year:

“Looking back at past oil price shocks, the real core risk has never been inflation—it has always been that economic growth faces significant pressure. Our base-case scenario is that U.S. growth continues to weaken in the second half of the year.”

The Fed drops clear forward guidance, and rising term premium amplifies market volatility

The structural adjustment to the policy framework pushed by Warsh is changing—at the root—the logic of how U.S. Treasuries are priced. The Fed is gradually moving away from the previous clear forward guidance and will no longer provide the market with signals about the interest-rate path in advance.

As analyzed by Amrut Nashikkar, Managing Director of Derivatives Strategy at Barclays, when there is no clear official guidance, at every FOMC meeting the market will have to wager on two possible outcomes—rate cuts or rate hikes—leading to a significant rise in uncertainty before and after policy implementation, with asset volatility increasing in tandem.

In the past, clear forward guidance could anchor market expectations, reduce volatility, and compress term premiums. Now that guidance has weakened, investors holding long-term bonds require greater risk compensation—meaning term premium rises. Even if inflation subsequently falls, long-end yields will be hard to decline quickly.

Guneet Dhingra, Head of U.S. Interest Rate Strategy at BNP Paribas, interprets the underlying logic of the Warsh reforms: “Warsh has made it clear that if the market fully follows the Fed’s expectations when trading, it would actually reduce the market’s pricing efficiency. In theory, after removing the constraints from guidance, the market can price the policy path purely on the basis of economic data. But in reality, this autonomous pricing comes at a cost: risk premiums rise, the probability of extreme tail events increases, and the overall market volatility center shifts upward permanently.”