(Bloomberg) -- Treasury yields plunged as traders boosted bets on how much the Federal Reserve might need to lower interest rates this year even as the central bank lifted its benchmark and Chair Jerome Powell said cuts aren’t something he expects.

The moves came despite the central bank hiking its benchmark by a quarter-point and signaled that it expects more tightening after that. It did however tweak its language around the outlook. 

The rally in Treasuries took the yield on the two-year yield down by as much as 25 basis points to 3.91%, before shifting back to around 3.99%. The swaps market shows a bit more than a one-in-two chance that officials will add another 25 basis points to their benchmark in May. 

“You’re starting to see cracks in certain things, and the market thinks that higher rates are going to break other things,” said Dan Mulholland, head of rates sales and trading at Crews & Associates in New York. The market is seeing “light at the end of the tunnel for rate increases.”

Expectations for cuts deepened, with the market suggesting that the effective fed funds rate will drop to around 4.18% in December. That’s below what was expected in earlier trading before the decision.

“I would not expect the market to take these rate cuts out in the near term and could very well price in more cuts if the data deteriorates from here,” Matthew Hornbach, global head of macro strategy at Morgan Stanley said on Bloomberg Television.

Powell himself, though, said in response to questioning that officials “just don’t” see rate cuts this year and that they will raise rates higher than expected if that is needed. “Rate cuts are not in our base case,” he said.

While pricing suggests cuts will come, some in the markets aren’t yet convinced that reductions are a given.

Wednesday’s comments “increase the odds the Fed could be done raising rates for this cycle,” but that “does not mean they will be cutting rates,” said Jack McIntyre, a portfolio manager at Brandywine.

Powell also stated that tighter credit conditions can substitute for rate hikes. 

The front end of the Treasuries curve led a rally in US debt after the decision, while the 10-year yield was down as much as 16 basis points to 3.45%.

The Federal Open Market Committee voted unanimously to increase its target for the federal funds rate to a range of 4.75% to 5%, the highest since September 2007, when rates were at their peak on the eve of the financial crisis. It’s the second straight rise of 25 basis points following a string of aggressive moves starting in March 2022, when rates were near zero.

Policymakers projected rates would end 2023 at about 5.1%, unchanged from their median estimate from the last round of forecasts in December. 

The latest hike to the target range is likely to put the current effective rate around 4.83% on Thursday.  Swaps show a peak for the cycle of around 4.96% in May, suggesting a little over one-in-two chance of a quarter-point hike.

--With assistance from Benjamin Purvis, Liz Capo McCormick and Edward Bolingbroke.

(Updates pricing, adds comments.)

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