Yield Curve Steadies Ahead of FOMC as Credit Markets Signal Caution

Author:

S3 Research Team

May 7, 2025

The market expects no immediate change from the Fed this week, but pricing now suggests rate cuts starting in July. While the yield curve has shifted slightly higher, the long and intermediate bond ETFs are showing stress with rising short interest. Credit ETFs and the dollar weakness add complexity to the outlook.

The CME Fed watch tool assigns a 96% probability that the target rate will be unchanged. This means there will be no significant market action unless there is a surprise which could result in extreme price action.

While a June rate cut was previously expected, the April jobs report has shifted expectations, with markets now anticipating a cut in July and a total of three cuts for the rest of the year.

There is a consensus of 50% chance of a later recession which would cause Fed action.

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The curve has shifted up slightly but has the same shape.

The long-dated ETF has fallen this week, and the short interest is higher. This coincides with the higher curve.

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The intermediate ETF short interest is growing, indicating shorting the bonds or higher yields which would make the curve flatten the long end.

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The S&P has recovered half its value, so the Fed is less concerned with the market. Despite this the S&P short position continues to grow as the market goes higher.

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All the credit ETFs show sign of distress which might be pricing in a recession.

The dollar at a low may be one of the things the Fed may worry about.

Despite the Fed's expected pause, structural shifts are appearing in interest rate-sensitive instruments. Growing short positions in SPX and ETFs reflect increasing concern around credit risk and curve behavior. Investors should be watching how the bond and credit markets evolve, especially if economic data confirms downside risk of growth or inflation.


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The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC (“S3 Partners”) to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks, and merits, as well as the legal, tax, accounting, and investment consequences, of such decisions.

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