• Rate futures initially rallied but lost momentum after weaker-than-expected retail sales figures.
  • Markets still price in a high probability of a Federal Reserve rate cut in September 2025.
  • The Fed funds rate is expected to decline to 4.25% by end of Q2 2025, with further cuts projected through 2027.

Retail Sales Cool Rate Futures Rally

U.S. short-term interest rate futures trimmed earlier gains Thursday after the latest retail sales data showed softer consumer activity than anticipated. While the numbers prompted some repositioning, traders maintained their conviction that the Federal Reserve will begin cutting rates in September 2025, with fed funds futures still reflecting about an 80% implied probability of easing at that meeting.

"The retail sales miss took some steam out of the rally, but it wasn't enough to shake the market's core belief that the Fed will need to act by September," said a rates trader at a major Wall Street bank who asked not to be named discussing client positions. "We're seeing some two-way flow now, but the dominant narrative hasn't changed."

The Data Behind the Move

The Commerce Department reported retail sales rose just 0.1% month-over-month in May, well below the 0.3% consensus estimate. Several analysts noted the weakness was concentrated in discretionary categories, suggesting consumers are becoming more selective with their spending amid elevated interest rates.

Fed funds futures had rallied earlier in the week on softer inflation data, with the December 2025 contract at one point pricing in nearly two full rate cuts for next year. Those positions were pared slightly after the retail figures, with the market now pricing in about 45 basis points of cuts for 2025.

What Comes Next

Attention now turns to upcoming labor market data and the Fed's preferred inflation gauge, the core PCE index, due later this month. "These are the numbers that could really move the needle on September expectations," the trader added. "For now, the market is taking this retail sales report as a yellow flag, not a red one."