• The Fed's shift toward data dependence and a tighter 2% inflation focus will increase bond-market volatility, especially in short-dated Treasurys, according to Julius Baer's Dario Messi.
  • Markets are pricing about 38 basis points of hikes by year-end, with rising sensitivity to economic data rather than Fed meetings.
  • Longer-dated yields remain more anchored by growth expectations, with limited upside risk and potential downside toward 4.30–4.40% on the 10-year.

Data-Driven Volatility

The Federal Reserve's pivot toward a more data-dependent stance, with a tighter focus on 2% inflation, is set to amplify bond-market volatility, particularly in short-dated Treasurys, according to Dario Messi, head of fixed income at Julius Baer. "The Fed is moving away from a calendar-based approach, which means every economic release will be a potential market mover," Messi said in an interview. "Short-dated yields will be more sensitive to data surprises, leading to higher volatility."

Markets are currently pricing about 38 basis points of rate hikes by year-end, a shift from earlier expectations of cuts. This repricing reflects growing sensitivity to macro data rather than Fed meeting outcomes. "We are seeing a regime where inflation and employment numbers matter more than FOMC statements," Messi added. "This could lead to sharper moves around CPI and payrolls releases."

Curve Dynamics

While short-dated Treasurys are likely to see heightened volatility, longer-dated yields are expected to be more anchored by growth expectations. The 10-year yield has limited upside risk, with potential to drift toward 4.30–4.40% on a data-driven selloff, Messi noted. "The long end is more tied to the economic outlook, and with growth moderating, there's a cap on yields," he said.

This divergence could steepen the yield curve, as short-term rates become more volatile while longer-term rates remain relatively stable. Investors are advised to adjust duration positioning accordingly. "We recommend a barbell strategy, with short-dated positions for income and long-dated ones for downside protection," Messi added.

Broader Implications

The Fed's pivot comes amid ongoing debates over inflation durability and labor market resilience. A more data-dependent approach could lead to a period of elevated volatility, similar to past episodes when the Fed shifted its reaction function. Global bond markets may also feel the ripple effects, with higher U.S. rate volatility spilling over into other currencies and fixed-income assets.

Correction: An earlier version of this article misstated the expected direction of rate moves. Markets are pricing hikes, not cuts, by year-end.