10Y: Positioning for a Falling Yield EnvironmentCBOT: Micro 10 Year Yield Futures ( CBOT_MINI:10Y1! ), #microfutures
The Federal Reserve last cut interest rates in December 2024. Since then, it has kept the rates unchanged in its January, March, April and June FOMC meetings. While the official Fed Funds rate stays at 4.25-4.50% in the past seven months, we have seen diverging trends in the interest rate market:
• 2-Year Yield has trended down from 4.25% to around 3.85%;
• 10-Year Yield mostly moved sideways, currently at 4.42%;
• 30-Year Yield rose from 4.60% to top 5.00% in May, then pulled back to 4.89%.
The futures market expects the Fed to cut rates once or twice in the remaining four FOMC meetings in 2025, according to CME Fed Watch Tool.
• As of July 20th, there is a 95.3% chance that the Fed will keep rates unchanged in its July 30th meeting;
• The odd of lowering 25 bps is approximately 60% for September 17th;
• By the last 2025 meeting on December 10th, futures market sees just 6.4% chance that the Fed keeps the rates at current level 4.25-4.50%, while the odds of 1 cut to 4.00-4.25% are 29.2%, and the odds of 2 cuts to 3.75-4.00% are 64.3%.
The Fed’s Challenges
The Fed tries to fulfil its dual mandate established by the Congress: (1) to support maximum employment and (2) to maintain price stability. Its official targets are to keep the unemployment rate below 4%, as measured by the BLS nonfarm payroll data, and to keep the inflation rate at 2%, as measured by the PCE price index. When we face an outlook of rising prices and slowing employment, the Fed will have a hard time meeting both policy goals.
Firstly, as the Trump Administration raises tariffs for all trading partners on all imports, it’s a matter of time before the inflation rate picks up again. Even if many countries may reach trade agreements with the U.S., they will still get a bigger tax bill.
• According to the Bureau of Economic Analysis (BEA), the total US imports of goods and services was $4.1 trillion for 2024.
• Imports account for 14% of the US GDP in 2024, which is $29.2 trillion (BEA data).
• Simple math suggests that a universal 10% tariff hike could contribute to 1.4% in price increases, assuming all tariffs are passed through to the retail prices.
The most recent inflation data is the June CPI at 2.7% (BLS data). The tariff hike could easily push inflation to twice the Fed policy target. Therefore, cutting rates will be a very difficult decision if inflation rebounds.
Secondly, US employment growth has slowed down significantly in 2025. On July 3rd, the BLS reported total nonfarm payroll increased by 147,000 in June, and the unemployment rate changed little at 4.1 percent. Current employment growth is less than half the level in December 2024, which saw the data above 300,000.
There are weaknesses in the payroll data. All private sectors combined accounted for about half of the employment gain, or 74,000. Government jobs, while at a much smaller base, accounted for the other half.
Tariffs raise the cost of input, while business borrowing costs remain high at current rate level. To support growth and maximum employment, cutting rates make sense.
Finally, the Fed is under tremendous pressure from the Administration. President Trump openly and repeatedly calls for a 300bp cut.
In an ideal world, the Fed wants to make monetary policy decisions free of political interference. It may not be the case. Let’s look at the Fed rate decisions during the first Trump presidential term. The current Fed Chair was appointed to the role by President Trump in February 2018.
• The Fed raised interest rates four times in 2018, for a total of 100 basis points, with the Fed Funds rate increased from 1.25-1.50% to 2.25-2.50%.
• Under pressure from the White House, the Fed cut rates three times in 2019 for a total of 75 basis points, with the Fed Funds rate ending at 1.50-1.75%.
• In 2020, in response to the Pandemic, the Fed cut rates by 150 points, all the way to a zero-rate environment (0%-0.25%).
In my opinion, the Fed will cut rates this year, similar to 2019. Once the Fed Chair retires in May 2026, his replacement, who will be nominated by President Trump, will no doubt follow his guidelines and bring the Fed Funds rate all the way down to 1%-2% level.
While there is uncertainty in the timing and pace, we are likely to embark on the path to low interest-rate environment.
Shorting Micro 10-Year Yield Futures
A trader sharing a bearish view on interest rates could explore shorting the CBOT Micro 10-Year Yield Futures ($10Y).
Last Friday, the August 10Y contract (10YQ5) was settled at 4.425. Each contract has a notional value of 1,000 index points, or a market value of $4,425. To buy or sell 1 contract, a trader is required to post an initial margin of $300. The margining requirement reflects a built-in leverage of 14.7-to-1.
Let’s use a hypothetical trade to illustrate how to use a short futures position to take advantage of a potential Fed rate cut.
Hypothetical Trade:
• Short 1 10YQ5 at 4.425, and set a stop loss at 4.60
• Trader pays $300 for initial margin
Scenario 1: Fed keeps rates unchanged on July 30th, 10Y moves sideways
• If Futures price changes little after the July FOMC, the trader could close the position
• He could short the September contract 10YU5, with an eye open for the September 17th FOMC rate decision
• This is a futures rollover strategy.
Scenario 2: Fed cuts 25 bps on July 30th, 10YU5 falls 250 points to 4.175
• Short position gains: $250 (= (4.425-4.175) x 1000)
• The hypothetical return will be 83% (= 250 / 300)
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
