From interest rate cuts to interest rate increases! The bond market’s expectations for the Fed’s policy path have undergone a historic shift

By Yang Chen, Bao Yilong

Source: Wall Street CN

Hammered by the Bank of England’s unexpected hawkish shift, a sell-off in UK gilts pushed U.S. Treasury yields higher. Coupled with the **unexpected drop in weekly jobless claims** released tonight, this has further eroded the rationale for the Federal Reserve to maintain an accommodative stance. Expectations for Fed rate cuts have been completely erased, and the market narrative has quickly reversed from “when to cut rates” to “whether to hike rates.” Jeff Gundlach, the “New Bond King,” noted that the 2-year U.S. Treasury yield signals the Federal Reserve may need to raise interest rates.

The global bond market is undergoing a profound repricing of policy expectations. Hit by the Bank of England’s hawkish pivot, traders have fully priced out the possibility of Federal Reserve rate cuts in 2026, and some investors have even begun hedging against a rate hike scenario in the coming months.

The Bank of England’s Monetary Policy Committee voted unanimously on Thursday to keep interest rates unchanged, while warning it stands “ready to act” against rising inflation risks sparked by the Middle East war.

This wording triggered a chain reaction: UK gilts were sold off, with the 2-year gilt yield surging more than 35 basis points in a single day to 4.46%. European bond markets followed suit, transmitting downward pressure to the U.S. Treasury market. The 2-year U.S. Treasury yield subsequently rose 11 basis points to 3.89%.

Meanwhile, the unexpected decline in weekly initial jobless claims reported by the U.S. Department of Labor further weakened the case for the Fed to stay dovish. The swap market has fully withdrawn expectations for Fed easing this year, and trading volume in U.S. Treasury futures has expanded significantly as yields climbed.

As the Middle East conflict drags on, oil prices have surged again. Bond traders have abandoned bets on U.S. rate cuts this year, and some have even started hedging against potential rate hikes in the months ahead. The “New Bond King” Jeff Gundlach argued that the 2-year U.S. Treasury yield suggests the Federal Reserve may raise rates.

### BoE Hawkish Shift Triggers Global Bond Market Repricing

Less than three weeks ago, markets widely expected the Bank of England to announce a rate cut at this meeting, as the UK labor market had been weakening consistently. However, the situation reversed sharply. Brent crude topped $118 per barrel on Thursday, and as energy-import-dependent economies, Europe and the UK face particularly acute imported inflation pressure.

BoE Governor Andrew Bailey stated clearly in the statement that monetary policy must “respond to the risk of more persistent effects on UK CPI inflation.” The swap market now prices in **three 25-basis-point rate hikes by the Bank of England this year**, with the first move expected as early as next month.

Seema Shah, Chief Global Strategist at Principal Asset Management, said: “The MPC has been forced into an abrupt U-turn. Even Swati Dhingra, the most dovish member of the committee, voted to hold rates, which underscores the central bank’s high alert over inflation.”

Luigi Buttiglione, Founder and CEO of LB Macro SA, pointed out: “Markets were clearly complacent, still fantasizing about a central bank more focused on output than inflation. But for an inflation-targeting institution like the BoE, this is not in its DNA when facing supply shocks.”

### Fed Rate Hike Hedges Emerge, Policy Path Tightens Suddenly

Fed Chair Jerome Powell said after Wednesday’s rate decision that further reductions in borrowing costs would depend on inflation trends, with language leaning noticeably cautious.

Tom di Galoma, Managing Director at Mischler Financial Group, said: “All of this is driven by the Bank of England’s decision. Markets are now pricing in a 50-basis-point Fed rate hike in 2026. European bonds are in free fall, which in turn is pushing up U.S. Treasury yields.”

He also noted that the current liquidity dynamic is characterized by “almost no buying interest, with sellers dominating everything,” as sentiment is held hostage by expectations of a prolonged conflict. “The prevailing view is that the Iran war could last for months, not weeks.”

The latest unexpected drop in weekly U.S. initial jobless claims provided further momentum for the bond sell-off. Strong labor market data suggest the U.S. economy may no longer need low rates to support employment, and the swap market has consequently priced out any form of Fed easing for the remainder of the year.

### Characteristics of the Global Bond Market Adjustment

The Middle East conflict drives up energy prices;

higher energy prices reinforce inflation expectations;

inflation expectations force central banks to adopt a tighter stance;

this in turn triggers a systematic repricing of rate-sensitive assets.

Within just a few weeks, the market narrative has shifted from “when to cut rates” to “whether to hike rates” — a reversal whose speed and magnitude have exceeded previous forecasts.

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