Why the Bond Market Expects Two More Rate Hikes and Three Cuts After That

Why the Bond Market Expects Two More Rate Hikes and Three Cuts After That

Omor Ibne Ehsan

Mon, September 14, 2026 at 5:03 PM GMT+3 5 min read

• SHY -0.04%

Quick Read

• SHY slipped 0.39% last week as the two-year Treasury yield climbed to 4.63%, nearly a full point above the 3.75% Fed funds rate.

• Markets pricing two hikes then three cuts reward short-end holders twice, giving them higher reinvestment income during tightening and then price gains as cuts pull yields lower.

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The bond market is pricing, according to CNBC, two hikes for the rest of the year, with the imminent meeting effectively decided and described as "next week's in the books". Yet the market also expects 3 cuts afterward. That sequence of tightening now and easing later is exactly what short-term Treasury pricing reflects.

If you own the iShares 1-3 Year Treasury Bond ETF (NASDAQ:SHY), this column walks through why the two-year note is the strongest piece of evidence and what it means for a fund that lives on the short end.

Why Cuts Survive Alongside Hikes

For both halves to happen, inflation must look sticky enough now to justify tightening, then cool convincingly enough later to justify reversal. Core PCE has risen every month in the supplied history, reaching 130.66 for July, the highest reading in the past year. The federal funds upper bound sits at 3.75%, unchanged since December 2025.

A defensive tightening against current inflation does not preclude cuts once that impulse fades. What breaks the sequence is either persistent inflation that removes the cuts, or a growth scare that collapses the hikes into cuts sooner.

Two-Year Note Yields Carry the Real Message

The two-year Treasury yield sits almost a full percentage point above the Fed funds rate, according to CNBC. On September 11, the two-year closed at 4.63%, against a 3.75% policy upper bound.

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That gap matters because the two-year rate reflects the average expected policy rate across a whole cycle, not just the next meeting. When it trades meaningfully above the current policy rate, the market is saying the average rate over the next 24 months will be higher than today. This reading is consistent with hikes arriving before cuts. The two-year has climbed sharply, from 4.37% on September 4 to 4.63% on September 11.

For SHY, which holds Treasuries in the 1-3 year window, rising short yields pressed the price down 0.39% over the past week while lifting the income the fund will earn on reinvestment. Year-to-date, the total return sits at 0.59%.

What the Dot Plot Still Does

The dot plot is the Summary of Economic Projections chart where each Fed policymaker anonymously marks an expectation for the federal funds rate at year-end for the next several years and the longer run. The dots are non-binding forecasts, not commitments.

Its relevance has been downplayed because the projections often diverge from what the Fed later does. It still works as a baseline because it is the only public read on where policymakers themselves think rates belong. Without a quarterly checkpoint from the Fed, daily yield moves in bills and short notes would play a larger role in how anyone reads policy direction.

Where SHY Fits in a Treasury Allocation

SHY charges a 0.15% expense ratio per the most recent prospectus. Against longer-duration Treasury funds, it gives up upside if cuts arrive faster than expected, because long duration benefits more from falling rates.

Against money market funds and T-bills, SHY takes slightly more duration risk in exchange for locking in yields further out the curve. Twelve-month T-bills yielded 4.23 on September 11, while the two-year sat at 4.63%.

If both halves of the sequence arrive, the short end pays a Treasury investor twice: higher reinvestment income during tightening, followed by modest price appreciation as cuts pull yields lower on existing holdings. The five-year return of 9.1% reflects a fund that rewards patience through cycles.

For an investor who wants Treasury exposure without long-duration volatility, SHY offers a straightforward vehicle at the current price of $81.37. Investors who need cash immediately tend to favor T-bills, while those expecting cuts to arrive far faster than the market prices tend to reach for longer duration, where price appreciation would be larger.

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