US Curve/Terminal Rate (Freebie Friday)
Freebie Friday
Terminal Rate Finds a Base: Markets Signal a Policy Floor
Over the past year or so, the market’s view of the “terminal rate” the peak level of policy rates in this cycle has shifted dramatically. What began as a relentless march higher in the wake of persistent inflation and aggressive central bank tightening has now evolved into a search for stability.
The blue line in the chart captures the yield of the highest-priced SOFR futures contract at any given point in time, a market-implied proxy for where traders believe the policy rate will ultimately settle. After peaking in late 2023 amid fears of entrenched inflation, this yield has undergone a steady retracement, reflecting the market’s pricing of future rate cuts as growth softened and inflation pressures eased.
But in recent months, the story has changed. Rather than continuing to grind lower, the market’s “terminal rate” has found a clear base. Volatility remains reflecting uncertainty around both the pace and depth of future easing but the underlying message is that traders now see a floor.
That floor is shaped by three key forces:
Resilient Core Inflation: While headline inflation has cooled, sticky components like services prices keep the Fed from cutting too deeply or too quickly.
Tricky geopolitical environment: Trump administration taking office with a aggressive trade policy pushed into action. This has made the Fed’s measure of neutral rate near impossible.
Global Divergence: In contrast to the US, some major central banks are already cutting aggressively, anchoring relative rate differentials and discouraging overly dovish pricing in US curves.
The orange line the actual Fed Funds effective rate highlights the lag between the policy rate and market expectations. The market is already looking beyond the current stance, mapping out a long-run equilibrium that is still historically high compared to the decade before 2022.
The days of relentless repricing lower in terminal rate expectations appear over. Instead, we’ve entered a range-bound regime where the market is testing the durability of this new policy floor. Unless incoming data forces the Fed’s hand, this base may hold well into the final stage of 2025 with profound implications for rate-sensitive assets, yield curve shape, and cross-asset allocation.
And finally we can see which contract ‘contains’ the terminal rate….. sitting in the 8th sofr contract (currently Mar27)
Am looking to establish March27-March28 long… expressing a quick recovery out of the cutting cycle. Note this trade will perform well with poor economic data with modest growth backdrop.