Recent US economic data and a stricter Federal Reserve have led markets to lower their expectations for interest rate cuts. The Federal Reserve is now expected to cut rates by 35 basis points (bps) by the end of the year, with only a 40% chance of a cut at the next meeting. In contrast, expectations for the European Central Bank (ECB) and the Bank of Canada (BoC) are 11 bps and 12 bps, respectively, with both anticipated to keep rates steady. The Bank of England (BoE) may cut rates by 46 bps, with an 82% probability of a cut at its upcoming meeting, while the Reserve Bank of Australia (RBA) is expected to cut rates by 60 bps. The Bank of Japan (BoJ) may increase rates by 17 bps, but there is an 86% chance they will maintain current rates. Both the ECB and BoC have shifted toward a more cautious stance due to inflation concerns, with the ECB facing possible inflation risks. The BoJ, on the other hand, seems less likely to raise rates soon.

Market Dynamics Shifting

As we move through the year, market focus is shifting from tariffs to economic data and guidance from the Federal Reserve. Past tariffs and legislation are becoming less relevant to market trends. Given the strong US data and the Federal Reserve’s solid position, we should prepare for a stronger US dollar. The June 2025 Consumer Price Index (CPI) report showed inflation steady at 3.2%, and the latest jobs report indicated the addition of 210,000 jobs. This supports the Fed’s choice to hold off on rate cuts, making the dollar more appealing against currencies from central banks likely to ease policies. Key opportunities may arise against the Australian dollar and the British pound. The market expects a 60 basis point cut from the RBA and a 46 basis point cut from the BoE by year-end. This difference in policy makes the US dollar a more attractive option, similar to what occurred between 2014 and 2015, when expectations of Fed tightening drove the dollar up.

Interest Rate Market Outlook

In the interest rate markets, we should expect US Treasury yields to stay high. The market now anticipates only 35 basis points of Fed cuts by the end of the year, down from 44, indicating that yields are unlikely to drop significantly. Using derivatives linked to Treasury futures to bet on higher interest rates could be a wise strategy. Previous market influences, such as tariff disputes that started in April 2024 and recent fiscal policies, have mostly been accounted for in price. The market is now closely watching every US inflation and employment report, which has become a key focus. This will likely lead to increased market volatility around these important data releases. We need to monitor incoming economic data closely, as it will determine the Fed’s next steps. A surprisingly weak jobs report or inflation number could quickly change today’s hawkish outlook. Currently, with the VIX volatility index trading at a relatively low 14, using options to express opinions or hedge against sudden changes may be a smart and cost-effective move. Create your live VT Markets account and start trading now.

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