Wall Street closed October with US stocks near record highs – Artificial Intelligence Optimism in various sectors, strong earnings reports from tech giants, and loose financial conditions collectively propelled the S&P 500 to its sixth consecutive monthly gain, while the credit market also rose for the third consecutive month. However, amid this renewed surge in risk assets, the Federal Reserve released more nuanced and complex signals.
Last week, Federal Reserve Chairman Jerome Powell stated in unusually blunt terms that a December rate cut was "far from" a certainty. The October rate cut decision itself was not unanimous—the first time in six years that the Fed had shown a two-way split—with some officials advocating for a larger cut, while others preferred to pause the action.
The breakdown of consensus within the Federal Reserve has reignited a familiar dilemma: what happens when the employment situation deteriorates but inflation risks remain high?
For many bond market investors, this actually brings a layer of uncertainty that they haven't had to consider for most of this year.
The market reaction was swift—US Treasury yields saw one of their biggest gains since 2022 on the day of the Fed's decision, which in turn boosted the dollar. The interest rate swap market is currently pricing in a roughly 70/30 probability of a Fed rate cut in December, whereas the probability of a rate cut was as high as 90% before the meeting.
For most of 2025, investors can treat the Federal Reserve's policy path as a known quantity. This allows US Treasuries to assume a dual function: both a defensive asset and a source of returns. Risk parity strategies, 60/40 portfolios, and credit-focused allocation strategies all benefit from declining interest rates and reduced volatility.
But Powell's comments suggest another possibility—the Federal Reserve may no longer act in unison, and the trade-off between inflation and employment will become more complex before it is resolved. If this is the case, bond investment strategies may become ineffective.
Short-term bonds, which are most sensitive to the Fed’s interest rate moves, are currently overvalued, while long-term bonds—more susceptible to inflation and growth surprises—remain vulnerable to an accelerated economic recovery.
Another sell-off of US Treasury bonds
Against this backdrop, "Bond King" Bill Gross is beginning to sell US Treasury futures, betting that high fiscal deficits and excessive issuance of Treasury bonds will continue to push up yields. Other investors are turning to medium-term bonds to reduce their exposure to short-term policy fluctuations.
“What you should do is not stand in the traffic,” said Dan Fuss of the Loomis Sayles Foundation, “but walk onto the median strip in the middle of the road.”
Powell's unexpected mention of "strong divergence" was corroborated by several Federal Reserve officials last Friday—Dallas Fed President Logan, Cleveland Fed President Hammark, and Kansas City Fed President Schmid all explained their reasons for maintaining interest rates unchanged; while Fed Governors Waller and Milan adopted dovish language. If economic data does not show signs of collapse, the market expects this divergence to persist for a longer period.
Bob Michele, head of global fixed income, currencies and commodities at JPMorgan Asset Management, noted: "If the data is mixed, dissent will continue to grow. Powell is gradually losing control over his Fed colleagues—look at his current situation; he's practically in the lame-duck phase of his term."
Pacific Ocean Gross, the over-80-year-old co-founder of investment management firm PIMCO, had previously warned the U.S. financial sector... Systemic risks are accumulating, and now he further states that the ever-expanding fiscal deficit and the weakening dollar are keeping him bearish on U.S. Treasury bonds.
“Trading strategy? I’m selling 10-year Treasury futures,” Gross wrote in an email. “Even if economic growth slows to 1-2%, there will still be an oversupply.”
Meanwhile, in the foreign exchange market, the Bloomberg Dollar Index has risen nearly 1% since Powell's speech on Wednesday, and even recorded its second monthly gain this year on Friday. Options market data shows that traders are generally optimistic about the dollar's performance over the next month.
The strength of U.S. Treasury yields is likely to support the dollar against major currencies, making it more attractive for global investors to hold dollar cash. For forex traders, this means buying the dollar against currencies like the yen—especially after Bank of Japan officials, led by Governor Kazuo Ueda, kept interest rates unchanged last week and hinted that future rate hikes might take time to materialize.
"If the Fed's rate cuts are expected to slow in magnitude or pace, this should support the dollar," Morgan Stanley said . Jim Caron, chief investment officer of the portfolio solutions group at the investment management firm, said in an interview.
Morgan Stanley 's foreign exchange trading desk colleagues had long been bearish on the dollar, but after the Federal Reserve's October interest rate meeting, they have shifted to a neutral stance and recommended closing short positions in the dollar against the euro and the yen.
(Article source: CLS)
