How to Interpret the Federal Reserve's Rate Cut Signals: Interpreting Tonight's FOMC Meeting Through Market Data

Tonight, the market is closely watching the Federal Open Market Committee (FOMC) meeting, but one key fact is often overlooked: the rate cut itself is usually already priced in by the market. What truly drives market volatility is not the rate cut itself, but the deviation between the actual outcome and market expectations.

I have previously emphasized that, regarding rate cuts, real interest rates and the magnitude and speed of the cuts are more important than nominal rates. These two factors are key signals driving asset price movements.

Today, I will guide you on how to capture these signals through data—transforming you from an ordinary observer into someone who can see beyond the surface and understand the real drivers of the market.

Interpreting Fed Rate Cut Signals: Tracking the Pace and Magnitude of Rate Cuts

1. Market Expectation Gap: CME FedWatch Tool Predicting Fed Rate Cut Probability

This is the most intuitive tool for quantifying the magnitude of rate cuts. It calculates the probability of rate cuts based on federal funds futures prices.

The key is not just whether the Fed will cut rates at the next meeting, but understanding the probability distribution of the cuts.

If the market initially expects a 25 basis point (bp) cut, but FedWatch shows the probability of a 50 basis point cut soaring from 10% to 40% within a few days, it indicates that the market is digesting a larger "recession narrative," and volatility will sharply increase.

Every change in rate cut expectations creates ripples in the market. As I mentioned earlier, the impact of rate cuts is often already priced in by the market—the real cause of price volatility is the deviation between actual outcomes and market expectations.

Pay close attention to the changes in market expectations for different magnitudes of rate cuts shown in the chart. These expectations ultimately depend on U.S. employment and inflation data.

https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html

2. Fed's Official Rate Cut Intent: Dot Plot

The dot plot is released quarterly and shows the individual forecasts of 19 Fed officials regarding future interest rates.

What we need to examine is the dispersion of the dots and the changes in the median.

If the dot plot shows a significant decline in the median rate by the end of 2026 compared to the previous quarter, it indicates that the Fed has raised the "ceiling" for rate cuts—this is a positive signal for the long term.

The above dot plot and the market expectation gap both help us gauge the magnitude of rate cuts.

3. Fed Rate Cut Pace: 10-Year vs. 2-Year U.S. Treasury Yield Curve Analysis

The 10-year vs. 2-year U.S. Treasury yield curve reveals professional bond traders' views on the pace of rate cuts.

The principle is simple:

• 2Y represents the policy interest rate for the next two years, directly controlled by the Fed's rate actions.
• 10Y represents long-term economic growth and inflation expectations.

What is the current situation? We are now in the "inverted yield curve reversal" phase (the 10-year Treasury yield has started to rise above the 2-year Treasury yield again, or the gap between the two is narrowing).

https://www.tradingview.com/chart/O9lEPyjs/?symbol=FRED%3AT10Y2Y

Understanding Yield Curve Inversion

Typically, due to longer duration and greater risk, long-term bonds should yield more than short-term bonds. If the yield on the 2-year bond exceeds that of the 10-year bond, this is called a yield curve inversion—an indicator of potential economic recession.

This phenomenon occurs when the market believes current inflation is too high or the Fed is significantly raising rates, causing short-term financing costs to soar. The 2-year Treasury yield is closely related to the policy rate.

Meanwhile, in the case of the 10-year Treasury, traders believe that due to the current high rates, the economy will eventually be "destroyed."

When the economy weakens, future inflation will dissipate, and the Fed will ultimately be forced to cut rates significantly. As a result, investors rush to buy long-term bonds to lock in current yields.

With more buyers, the price of the 10-year U.S. Treasury rises, leading to a decline in yields.

This is why we can see from the chart that the 10-year vs. 2-year yield curve was previously inverted, changing from -1.04 in 2023 to the current 0.57, gradually reversing the inversion trend.

How to Interpret Fed Rate Cut Signals from Yield Curve Reversal

From the 10-year to 2-year Treasury yield curve, the trend is upward, but the distinction lies in what factors are driving this growth.

Remember this formula: 10Y - 2Y

Bullish steepening with rapid rate cuts is favorable for liquidity.

• Spread chart behavior: The curve steepens sharply and rises quickly.
• The reality is: The decline in the 2-year Treasury yield (short-term) is much faster than that of the 10-year Treasury yield.
• Market logic: Weak economic data leads the market to believe the Fed will quickly and significantly cut rates.

Bearish steepening—slow rate cuts/inflation rebound is unfavorable for liquidity.

• Spread chart behavior: The curve rises slowly or fluctuates upward repeatedly (as shown in the chart for early 2026).
• The reality is: The 10-year Treasury yield (long-term) is rising, while the rise or fall of the 2-year Treasury yield is very slow.
• Market logic: The market is concerned about an inflation rebound (expectations of rising inflation) or believes the economy is too strong for the Fed to need to cut rates.

Clearly, we are currently in a phase of bearish steepening. Observing the 10-year and 2-year yield curves separately, both show a recent upward trend over the past five years.

This indicates that the current inclination for rate cuts leans towards "preemptive cuts"—the Fed is gradually cutting rates, like squeezing toothpaste, stopping after each little bit.

When will the market truly feel the impact of Fed rate cuts?

Only when the 10-year vs. 2-year yield curve can steepen more significantly will the cryptocurrency market see liquidity, and asset prices can truly soar.

When liquidity is injected, various industry narratives will emerge to ignite the market.

Narratives are merely surface appearances—narratives can come from any field, just like an actor pushed onto the stage. What truly matters is how many paying audience members are watching from below.

The above views are from @AAAce4518

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