As the expectation of interest rate cuts heats up, US Treasury bonds have risen for five consecutive months. Will the fragile uptrend be shattered by the Federal Reserve's interest rate decision?

According to the financial news app Zhitong Finance, US Treasury bonds have been rising for five consecutive months, pushing short-term yields sensitive to Fed policy to their lowest level in two years. The two-year Treasury yield, sensitive to policy changes, has dropped significantly from nearly 5% at the end of April to around 3.5% this week, hitting its lowest point since September 2022. This is due to easing price pressures and signs of weakness in the labor market, leading to increasing market expectations of a Fed rate cut.

Bond investors who have been betting on the Fed's first rate cut in four years are about to find out if their trades are correct. In early September, the market unanimously believed that the Fed would cut rates by 25 basis points this week. However, after reports indicated a divergence among Fed officials on whether to take a more aggressive policy path, traders increased their bets on a 50 basis point rate cut. Despite the Fed holding its most uncertain policy meeting since 2007, the number of traders betting on a significant rate cut has reached a record high. Therefore, if Fed officials ultimately choose a more moderate 25 basis point rate cut, all traders who bet on a significant rate cut will face huge losses.

Former New York Fed Chair Dudley recently stated that the Fed faces a key decision at this week's meeting: whether to make a moderate 25 basis point rate cut or to directly cut rates by 50 basis points to curb an economic recession. Dudley also believes that Fed Chair Powell favors taking aggressive action, as Powell mentioned last month at the Jackson Hole meeting that further softening in the labor market is "unwelcome," and the job market seems to be deteriorating further.

Dudley also mentioned that monetary policy is in a tight position when it should be neutral or loose. With a larger rate cut, the Fed can more easily align the dot plot forecast with market expectations, rather than throwing out an economically unsupported and market-unfriendly surprise.

George Catrambone, head of fixed income at DWS Americas, said, "The Fed will have to strike a balance in this regard. In terms of the rate cut magnitude priced in by traders, this is an imbalanced market."

Edward Harrison, macro strategist at Bloomberg, said, "For US Treasury bonds that have already risen significantly, if the Fed chooses a 25 basis point rate cut, most risks will be to the downside. More importantly, if the Fed does cut by 25 basis points, it could signal a 25 basis point cut in the subsequent press conference. This means that the market's expectation of a 116 basis point rate cut by the end of the year could be repriced."

"Some market participants believe that expectations for rate cuts, whether this week or next year, have gone too far. RJ O'Brien Managing Director John Brady said, "This will be a life-and-death struggle." "The key issue is whether the Federal Reserve Chairman has received full support from the Federal Open Market Committee (FOMC) for a 50 basis point rate cut."

Daniel Ivascyn, who manages the world's largest actively managed fixed-income fund at Pacific Investment Management Company (PIMCO), said, "We do believe that the market may have been a bit ahead of itself in terms of expectations for a rate cut in the near term. There is a risk of some inflation reacceleration in the coming months, which could result in a rate cut that is lower than what the market has priced in."

In addition to the rate cut itself, factors affecting the U.S. bond market include Federal Reserve officials' forecasts for the overall magnitude of rate cuts over the next two years, as well as the tone of Powell's remarks at the press conference. Over the past two years, there has been a trend of U.S. bonds rebounding after the Fed announces its rate decisions. For example, in the 20 days following the announcement of rate decisions, the yield on the 10-year U.S. Treasury bond declined on 17 of those days, with an average decrease of 7 basis points.

Sinead Colton Grant, Chief Investment Officer at New York Bank Wealth, said, "The Fed relies on data, and we believe the U.S. economy may be heading for a soft landing. Due to several weak employment reports and further slowdown in inflation, the yield on the 10-year U.S. Treasury bond may fall to a low of 3% to 3.25%."