Fed rate hikes are back in the conversation. Here’s why, and what could trigger them.
While Federal Reserve policymakers aren’t expected to lower interest rates on Wednesday, questions about potential rate hikes have entered the conversation.
A team of analysts at Barclays said Tuesday they still expect slightly lower rates over the course of 2025. However, they also aren’t entirely ruling interest-rate hikes out, especially since the options markets has begun pricing in a roughly 25% probability of such a hike.
“We believe that the bar for the committee to reverse its cutting cycle is quite high,” a team of Barclays macro researchers wrote in Tuesday client note. “In large part, this reflects the perceived hit to its credibility that would likely occur if needed to backtrack on rates.”
Yet if “the totality” of the data changes to include a reacceleration of inflation, rising inflation expectations or a convincing decline in the unemployment rate, the team said rate hikes could be on the table.
To inform their view, the Barclays team studied three prior episodes when the Fed reversed course on rates via hikes in March 1997 and June 1999, as well as a period from late 2021 to early 2022. The third episode covered a stretch when the Fed first began tapering its balance-sheet growth, viewed as a surrogate for rate hikes, and later by signaling that rate hikes were on the docket.
The Barclays team found that tightening labor markets were a consistent feature of all three policy reversals, while a backdrop of strong economic growth and a steepening of the yield curve also played roles.
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How markets would react
The benchmark 10-year Treasury yield BX:TMUBMUSD10Y has already moved above its shorter 3-month BX:TMUBMUSD03M counterpart in recent months — reflecting a repricing based on economic resilience, but also concerns about policy priorities of the second Trump administration that could reignite inflation.
Shorter-term rates, however, moved lower as the Fed first started cutting rates in September.
The Fed lowered rates again in December, bringing its policy rate to a 4.25% to 4.50% range, while signaling future cuts could come more slowly . The current range is 1% below the central bank’s peak policy rate so far in this cycle, which was a 23-year high .
Should a rate hike look imminent, the Barclays team said the 2-year BX:TMUBMUSD02Y and 10-year Treasury yields would initially eclipse 5%. The bank’s equity strategist in April warned that the 10-year yield hitting 5% would be problematic for equities.
Major U.S. stock indexes were at or approaching record levels before Monday’s sharp selloff, which was triggered by concerns that China’s DeepSeek artificial-intelligence platform could deliver cheaper alternatives to U.S-based AI models. The S&P 500 index SPX and Nasdaq Composite COMP on Tuesday were on pace to claw backs some of those losses , while battered Nvidia Corp. NVDA shares were up more than 6% at last check, according to Factset.
Another area to watch would be the Treasury bill market. The Barclays team said they expect short-term Treasury rates to significantly reprice if the Fed were to opt to hike, with higher rates likely to further swell the roughly $7 trillion money-market fund industry and potentially pressure bank deposits lower.
Still, expectations around the Fed’s rate policy have been tilting slightly toward more cuts in 2025. Fed-funds futures traders on Tuesday had the odds favoring 50 basis points of Fed rate cuts this year, versus only 25 basis points of cuts a week ago, according to the CME FedWatch Tool.
That will keep focus on what Fed Chair Jerome Powell has to say during Wednesday afternoon’s press conference, but also on Friday’s reading of the Fed’s preferred inflation gauge, the personal-consumption expenditures index for December .
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