Wall Street is starting to rethink the need for multiple rate cuts into 2026

Financial-market participants are scaling back slightly on their expectations for as many as five to seven interest-rate cuts by October 2026 following unexpectedly strong U.S. data on Thursday. - Agence France-Presse/Getty Images

The U.S. economy is looking stronger than many people previously thought, prompting a reconsideration by traders of how low interest rates might need to go into next year.

The rethink unfolded in a subtle way after Thursday’s data showed fewer-than-expected initial jobless claims and a surprising upward revision in second-quarter economic growth. The market-implied likelihood of a quarter-point rate cut by the Federal Reserve in October briefly slipped to 85.5%, from 91.9% a day ago, according to the CME FedWatch Tool. Meanwhile, expectations for a similar-size move by December also fell, along with the chances of additional easing into next year.

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For now, the economy is signaling “more strength, less need for rate cuts,” said economists Lindsey Piegza and Lauren Henderson at Stifel, Nicolaus & Co. in Chicago. In a note, they wrote that “an even stronger growth profile in Q2, led by additional strength in consumption and investment, reiterates the storyline of a solid economy despite fiscal-policy uncertainty, relatively elevated price pressures and a reduced pace of hiring.”

The impact of this surprising economic strength showed up on Thursday in the form of selling in the bond market, sending yields higher on everything from the 1-month Treasury bill BX:TMUBMUSD01M through the 20-year bond. The benchmark 10-year Treasury rate BX:TMUBMUSD10Y rose as much as 5.5 basis points to an intraday high of almost 4.2%, after breaking through the key support level of 4.15%. It finished at a three-week high of 4.17%.

Thursday’s climb in yields appeared to reflect reduced concerns about the possibility that a softening labor market might translate into broader economic weakness and require the Fed to keep cutting interest rates. Meanwhile, stock-market investors, who have been hopeful about getting multiple rate cuts without a recession, handed the Dow Jones Industrial Average DJIA, the S&P 500 SPX, and the Nasdaq Composite COMP their first joint three-day losing streak in months.

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“Our view is that there are two types of consumers, creating two different sides to this market,” said portfolio manager Brian Mulberry of Chicago-based Zacks Investment Management.

“There are those who owned homes during the pandemic, refinanced their mortgages at 2.5% to 3%, paid off their loans and are not feeling the price pressure of inflation. Consumers who didn’t own a home or other assets during this five-year period of time are really struggling, and that is showing through as a bifurcated economy,” Mulberry said in a phone interview. “We can make the case that asset owners are still driving growth in the economy. But if they turn negative, start saving and stop spending, we could see a risk of slowing growth or stagflation.”

Last week, Fed officials cut rates by a quarter of a percentage point, to between 4% and 4.25%, to address downside risks to employment and signaled two more moves of the same size would likely occur by December, followed by a third reduction in 2026. By comparison, fed-funds futures traders have priced in a decent chance of as many as five quarter-point rate cuts by October of next year, and continued to cling to smaller likelihoods of up to six or seven cuts — even after scaling back their expectations on Thursday.

Thursday’s selling of U.S. government debt sent the policy-sensitive 2-year yield BX:TMUBMUSD02Y up by 6.5 basis points to 3.66% or the highest level in about a month. The 30-year rate BX:TMUBMUSD30Y finished little changed at 4.75%.

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