Fed’s “Higher-for-Longer” Credibility Being Tested — Evening Brief – 07.02.25 

Investor confidence in the Federal Reserve’s “higher-for-longer” stance is showing cracks as fresh market signals and intensifying political noise push expectations for earlier policy easing. While the central bank is still widely expected to keep its benchmark rate unchanged at the July 29–30 FOMC meeting, market conviction in that steady path is weakening, with bets on a September cut gaining traction. 

Futures markets now reflect a 79% probability that the Fed will hold rates steady next month — down from near-certainty in recent weeks — while the odds of a rate cut in September have climbed to roughly 90%, according to CME FedWatch data. That shift marks one of the most dovish pivots in sentiment this year. 

This realignment is clearly visible in the rates complex. The yield on the policy-sensitive 2-year Treasury note has dropped to 3.71%, the lowest level in nearly two months, widening its gap relative to the Fed’s median policy rate. That spread suggests bond investors see growing odds the Fed will be forced to pivot sooner than its own dot plot indicates. 

A major factor behind this repricing is emerging weakness in the labor market. Initial jobless claims have moderated slightly after spiking, but continuing claims jumped to a 3.5-year high, signaling that displaced workers are struggling to secure new employment. “The data are consistent with softening labor market conditions, particularly on the hiring side of the labor market equation,” noted Nancy Vanden Houten, lead U.S. economist at Oxford Economics. “For now, we don’t think the labor market is weak enough to prompt the Fed to cut rates before December, but the risk is increasing that once the Fed starts to lower rates, it will have some catching up to do.” 

Meanwhile, political developments could add another layer of uncertainty. Reports suggest President Trump may seek to announce a replacement for Fed Chair Jerome Powell well ahead of the end of his term next May — a move that could escalate pressure on the Fed to deliver cuts sooner, especially in an election year. 

Desks are responding to these crosscurrents by repositioning short duration and curve steepener trades. If the labor market deteriorates further or political moves undermine perceptions of the Fed’s independence, bond market volatility could pick up quickly. The MOVE Index — the so-called “VIX of bonds” — sits at its lowest level since February, a signal that traders may be underpricing the potential for swings if the policy outlook shifts abruptly. 

For now, the Fed’s leadership continues to stress patience and a data-dependent approach. But with the economic backdrop shifting and election season heating up, the market’s message is growing louder: the Fed’s wait-and-see strategy may not be sustainable if growth cracks widen and the political calendar accelerates the countdown to a policy pivot.