Bond markets are increasingly pricing in the possibility that the Federal Reserve’s next move could be a rate hike rather than a cut, as investors reassess the policy outlook ahead of Kevin Warsh’s expected tenure as Fed chair, according to a report by Bloomberg.
Interest rate swaps tied to central bank policy decisions now imply more than a 50% probability that the Fed raises rates by April of next year before subsequently easing. At the same time, derivatives markets show rising demand for hedges against a further increase in hike expectations through the end of this year.
The shift in positioning comes amid growing division among policymakers on the inflation outlook, just as leadership transitions to Warsh following political pressure from US President Donald Trump for lower borrowing costs.
Market participants note that geopolitical risks, including the ongoing Iran-related conflict, are complicating the inflation and growth picture. Some strategists suggest that while rate cuts are still possible later in the cycle, persistent energy-driven inflation pressures could delay easing.
Attention is also turning to upcoming US labour market data, which could reinforce expectations that employment conditions are stabilising. That scenario would allow inflation concerns—particularly those linked to energy shocks—to take priority in Fed deliberations.
Analysts at Evercore ISI argue that a steady labour market would give policymakers room to focus on managing inflation risks stemming from higher oil prices before considering policy loosening. Their base case still includes eventual rate cuts, though on a delayed timeline due to the conflict-driven inflation shock.
In the swaps market, expectations for policy easing have been pushed further out, with pricing now indicating lower rates may not materialise until early 2028. The March 2028 Fed swap is trading several basis points below the current effective funds rate, reflecting a prolonged higher-for-longer stance.
Short-end futures markets have also shown stress, particularly around mid-2027 contracts, which have lagged as traders reassess the probability of a hiking cycle emerging within the next 6–12 months. The resulting dislocations have widened curve structure trades to multi-year highs.
Market commentary suggests the front end of the US curve has been slow to reflect the possibility of renewed tightening. Some portfolio managers argue that markets are underestimating the potential for a policy shift back toward hikes if inflation proves persistent.
Options activity in SOFR markets has also picked up, with traders increasingly buying protection against a rise in rate-hike probabilities over the course of the year. Futures positioning data shows a mix of liquidation and new short exposure, with risk increasingly pushed into later-dated contracts where hiking expectations are most pronounced.
In parallel, broader fixed income positioning has turned more defensive. Treasury client surveys show investors increasing short positions, while long-dated yields remain elevated, with 30-year US government bonds trading near the 5% mark after briefly breaching that level.
Across the options market, skew continues to favour protection against rising yields, particularly at the long end of the curve. While some hedging flows still anticipate yield declines in parts of the curve, overall positioning reflects a market increasingly cautious about upside inflation risk and the possibility of a delayed easing cycle.
