The US Federal Reserve’s decision to cut interest rates 0.25% – the first cut this year – was widely expected, and leaves investors looking for more signs of what is to come.
The one clear message is that investors are finding bonds even more attractive.
The market reaction to the cut has been initially muted, but yields on intermediate-maturity US Treasuries rose. Rates now stand at a range of 4% to 4.25%, the lowest since November 2022.
Ahead of the meeting, futures markets were already pricing a high probability of two additional 25-basis points rate cuts this year.
The Fed’s longer-run path toward neutral had already been priced in as well, as investors anticipated that policymakers would respond to deteriorating labour conditions.
“This signals a weakening, but not too cold US economy,” said Gerrit Smit, head of global equity management at Stonehage Fleming Investment Management. “Historically, a Fed cut with the stock market close to an all-time high, was predominantly followed by continuing strong stock market performance.”
Joyce Huang, co-head investment strategist at American Century Investments, admitted that “this is the outcome we expected” and is “in line with our team’s current market outlook.”
Huang expects “a slowdown in the US economy to continue over the next six months into the first quarter of 2026.”
Huang says this all makes bonds appealing to investors: “We see this as a positive for bonds and believe investors should allocate away from cash and floating rate instruments and add duration to benefit from falling rates in the short end of the yield curve.”
David Rees, head of global economics at Schroders, noted risks connected with the decision to cut.
“The Fed’s decision to press ahead with interest rate cuts at a time when the solid economy is close to full employment raises the risk of higher inflation becoming ingrained. We now think that the Fed will deliver another two 0.25% cuts by the end of 2025,” he said.
But Rees noted rates are unlikely to fall further. “As solid growth drives a rebound in labour market activity and causes inflation to rise. As such, we continue to believe that market expectations of rates going below 3% are too aggressive.”
The decision to cut, it should be noted, was not unanimous. Newly confirmed Governor Stephen Miran dissented in favor of a larger 50-basis point cut.
Nonetheless, the majority of officials appear to support a gradual path toward neutral monetary policy – which the central bank estimates to be around 3% – over the next few years.
Michaël Nizard, head of multi-asset and overlay at Edmond de Rothschild Asset Management, said the real issue at stake at the Fed meeting was the change in the projections of Fed members, who were anticipating only two rate cuts this year and one in 2026.
“The changing economic situation undoubtedly justifies an adjustment to these projections, but we believe it is unlikely that they will align with the relatively aggressive market positioning today, which would not be desirable given the potentially negative repercussions, particularly for anchoring inflation expectations,” Nizard said.
For the Fed, anticipating more than two rate cuts next year would signal serious concern about the risk of recession in the United States – an alarmist message it will seek to avoid.
“Powell is likely to emphasise instead the need to gradually bring interest rates back to a neutral level, given that monetary policy is currently considered ‘moderately restrictive,’” said Nizard.
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