• Traders price in roughly half a 25bp rate hike by April 2027, signaling a cautious tightening path.
  • The implied terminal rate suggests fewer and smaller increases than earlier anticipated.
  • Market expectations remain data-dependent, with inflation and labor reports key to future shifts.

Gradual Tightening Ahead

Fed swaps are now pricing in about 50% of a 25 basis point rate hike by April 2027, according to people familiar with the matter. This implies that market participants expect the central bank to raise rates by just 12.5 basis points over the next two years, a far cry from the aggressive tightening seen in prior cycles. The pricing reflects a growing belief that inflation will moderate without requiring significant further action from the Fed.

“The market is essentially betting on a very shallow path to the terminal rate,” a fixed-income strategist at a major bank said, declining to be named. “It’s a stark shift from where we were a year ago.”

The move in swaps comes as recent data showed inflation easing, with the core PCE price index rising at an annualized rate of 2.8% in the latest reading, down from a peak of 5.6% in 2022. However, the labor market remains resilient, with unemployment at 3.7%, complicating the Fed’s calculus.

Implications for Markets

The partial pricing of a hike by 2027 has supported bond valuations, as it implies a slower path to restrictive policy. The yield on the 10-year Treasury note has hovered around 4.2%, down from highs above 5% in late 2023. Equities have been mixed, with growth stocks benefiting from lower discount rates while financials weigh the impact of still-elevated short-term rates.

“The swaps market is telling us that the Fed’s terminal rate may be lower than previously thought,” said a portfolio manager at an asset management firm. “But everything hinges on incoming data—if inflation picks up, you could see a rapid repricing.”

Data Dependency

The pricing remains highly sensitive to economic releases. The next CPI report, due in two weeks, will be closely watched. Any upside surprise could push swaps back toward pricing a full hike, while signs of a slowdown might further reduce expectations. The Fed’s own dot plot, last updated in December, showed a median terminal rate of 2.75% for 2027, slightly above the current market implied rate of around 2.6%.

*Correction: An earlier version of this article misstated the timing of the next CPI report." The report is due in two weeks, not one.