Key Highlights

• Divergent views and lack of meaningful data lead to gyrating rate cut expectations
• Not enough data before December for Fed consensus, but we may gain clarity in January
• Foreign demand for USTs has softened recently

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Divergent views, no data, lead to changing rate cut expectations

EXHIBIT #1:  DECEMBER RATE EXPECTATIONS VOLATILE

_{Source: BNY Markets, Bloomberg}

Views on a possible rate cut at the December 10 FOMC meeting have been volatile over the last six or seven weeks. Currently, the market is betting on a more than 85% chance of a move in December. While we think the likelihood is somewhat less certain, we lean in favor of a reduction in the policy rate, though we believe it will be a close decision when all is said and done.

Exhibit #1 shows the evolution of the OIOS-implied rate cut probabilities for December 2025 and January 2026, going back to just before the October 29 FOMC meeting, when the Fed cut rates despite a two-sided dissent and a warning that a December move was “far from” a foregone conclusion. As a result, note the significant movement in these odds, especially for December. Before the October meeting, markets were nearly certain of a December cut until Fed Chair Jerome Powell’s press conference, when he poured, if not cold, at least lukewarm water on the next meeting. Probabilities fell to around 50-50 as a result.

They fell further last Wednesday when the BLS announced that October jobs and inflation reports would not be published at all, and that November data would come out after the December 10 Fed meeting. This news led the market to believe that a cut in December was unlikely, and that it would more likely occur on January 29, 2026, after a full cycle of the most recent data has passed. If there is no cut in December as the result of missing data, it would most likely occur in January instead. However, late last week, New York Fed President John Williams spoke in favor of a December cut. Williams is often viewed as a proxy for Chair Powell’s views, and his comments were interpreted as implying Powell’s support, even though the Chair hasn’t spoken publicly since the October meeting. Probabilities for a cut, as of this writing, are now around 85%.

The volatility in rate cut expectations over such a short period indicates to us that convictions remain weak, something we ourselves admitted last week with respect to our December cut call. At present, we lean toward a cut next month, although it is indeed a close call. Perhaps we’re hedging when we argue that, if the Fed doesn’t move in December due to lack of a clear picture of where the economy is at present, it will have enough of a reason to do so in January. To us, it’s really just a question of when the FOMC sees enough evidence of labor market weakening to feel confident in easing. We think the data we do have at present indicate weakness is happening, but many at the Fed have dismissed concerns about labor market weakness in favor of inflation vigilance.

As Chair Powell asserted in his October press conference, “At a time when we have tension between our two goals, we have strong views across the Committee.” This is still the case a month later, as can be easily surmised from the competing views – and reasoning for these views – expressed by both hawkish and dovish members since the October meeting. The recently published minutes from that meeting summarize this wide-ranging debate among members.

We think this divergence of opinions and public advocacy for these views reflect a Fed that is grappling with the same set of issues facing market participants: an economy at an inflection point without data pointing to a clear outlook, and the risk that the Fed’s two goals, price stability and full employment, are moving away from their respective targets. These factors set up such a close call for December. We think that Fed and market views will coalesce once the data catch up and we start to get a comprehensive picture of the economy, and that we’ll have another rate cut eventually, whether in December or January.

The minutes reflect these divergent views. Probably the most revealing information we’ll receive between now and the December 10 meeting will come in the form of the Fed’s Beige Book, due Wednesday, which qualitatively describes economic developments in the various Federal Reserve regions and paints a holistic picture of the economy. We’re not sure the Beige Book alone will be sufficient to change minds, but it could set the early tone for expectations for January.

A check-in on cross-border Treasury demand

EXHIBIT #2: CONTOURS OF CROSS-BORDER DEMAND FOR USTS

_{Source: BNY Markets, iFlow}

It's been a while since we have checked in on our cross-border iFlow data to gauge foreign demand for USTs. Broadly speaking, demand has waxed and waned. In recent weeks, we’ve seen meaningful and persistent UST selling by offshore participants. Recall that our data apply to real money long-only investors – such as asset managers, insurance companies, asset owners – not official institutions, reserve managers or sovereign wealth funds.

Exhibit #2 shows the cumulative flows of these long-only investors into all USTs across the curve (blue area), and specifically, the 7–10y maturity bucket – a proxy for longer duration sovereign assets. Note that the up-and-down movement of the plots indicates this to-and-fro movement over the last 12 months. Selling accelerated in early 2025 after the President’s inauguration with initial tariff and budget discussions, and then really picked up in April, hitting a local low mid-month. From May through September, there was a gradual return to the market from abroad, but mid-September saw another leg lower – both for all USTs and the intermediate-to-long sector of the yield curve.

EXHIBIT #3: OVERSEAS UST HOLDINGS DOWN FROM PEAK, CLOSE TO AVERAGE

_{Source: BNY Markets, iFlow}

Over a longer span, we can see that current cross-border holdings of USTs are more or less in line with the average level observed since 2018. Indeed, leading up to April 2025, U.S. holdings reached post-2018 highs and have come off since then. We don’t view these recent outflows as indicative of a wholesale flight out of U.S. assets, but a change in investor preferences after the Fed initiated its rate-cutting cycle over a year ago. Nevertheless, it would seem to us that the recent softness in foreign demand has kept 10y yields from dipping meaningfully or sustainably below 4% (currently 4.04%). This is the case even as Fed rate-cut pricing has moved shorter-term yields in response to changing perceptions about a cut’s likelihood, as discussed above.

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