While the Federal Reserve is widely expected to hold interest rates steady on Wednesday, discussions around potential hikes have gained traction.
Analysts at Barclays reaffirmed their expectation for slightly lower rates through 2025 but cautioned that rate hikes aren’t entirely off the table. Options markets have begun pricing in a roughly 25% probability of an increase.
“The bar for the Fed to reverse its rate-cutting cycle remains high,” Barclays macro researchers wrote in a client note Tuesday. “A policy reversal could undermine the Fed’s credibility, making it a difficult decision.”
However, the team noted that if economic data starts signaling a resurgence in inflation, rising inflation expectations, or a sharp decline in unemployment, rate hikes could become a real possibility.
Historical Precedents
Barclays analysts examined three past instances where the Fed shifted back to tightening:
- March 1997 and June 1999: Rate hikes followed tightening labor markets and strong economic growth.
- Late 2021 to Early 2022: The Fed tapered balance-sheet expansion, a move seen as a precursor to rate hikes, before explicitly signaling increases.
In all three cases, labor market strength and a steepening yield curve were key factors.
Market Reactions
The benchmark 10-year Treasury yield (4.52%) has already risen above the 3-month Treasury yield (4.29%), reflecting economic resilience and policy concerns tied to a potential second Trump administration.
Short-term yields initially fell as the Fed began rate cuts in September and December, bringing the policy rate to 4.25%–4.50%, a full percentage point below its cycle peak.
Should rate hikes materialize, Barclays expects the 2-year and 10-year Treasury yields to exceed 5%, which could pressure equities. The bank’s equity strategists previously warned that a 10-year yield above 5% could pose risks for stock markets.
Watching the Treasury Market
A potential rate hike could also trigger a repricing in the Treasury bill market, driving up short-term rates. This, in turn, could further expand the $7 trillion money-market fund industry while pressuring bank deposits.
Fed’s Next Moves
Despite renewed rate hike discussions, expectations still lean toward further rate cuts in 2025. As of Tuesday, Fed-funds futures traders priced in a 50-basis-point cut this year, up from 25 basis points the prior week, per the CME FedWatch Tool.
All eyes are now on Fed Chair Jerome Powell’s remarks during Wednesday’s press conference and Friday’s release of the Fed’s preferred inflation gauge—the December personal consumption expenditures (PCE) index.
