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Fed Cuts Rates Amid Mixed Economic Data, Trump Victory

Changing dynamics in the federal government and the fixed-income market highlight opportunities to redeploy cash equivalents.

11/07/2024

Key Takeaways

For the second time in two months, the Fed lowered its short-term interest rate target, this time by a quarter-point.

Policymakers will likely pursue a wait-and-see interest rate approach as President-elect Donald Trump’s policy priorities unfold.

We believe Fed strategy and Treasury market volatility have created an opportunistic backdrop to shift fixed-income exposure.

Following September’s hefty half-point rate cut, the Federal Reserve (Fed) lowered the federal funds rate target by a quarter-point on November 7. The Fed’s target lending rate now ranges from 4.5% to 4.75%.

The easing move followed some mixed economic metrics released recently, including slower but still-resilient third-quarter gross domestic product (GDP) and plunging job growth. Headline inflation moderated for the sixth straight month in September, while core inflation inched higher.

Following this second consecutive rate cut, we expect yields on cash-equivalent accounts to decline. At the same time, we expect Treasury yields to remain volatile as markets and the Fed respond to prevailing data and Trump administration priorities. We believe this scenario highlights timely opportunities in fixed income, particularly in high-quality short-duration bonds.

Fed Expects More Cuts, but Pace Is Unclear

At his post-meeting press conference, Fed Board Chair Jerome Powell indicated that the latest rate cut reflects the continued recalibration of interest rate policy. He said the economy is still strong, the labor market is solid, and 2% core inflation (excludes food and energy prices) remains within reach. He also reiterated the central bank’s goal of implementing an easing strategy that prevents job market weakness while maintaining economic resilience.

In achieving that goal, policymakers seek a return to “normal” interest rate policy, but defining “normal” remains challenging. In the post-financial crisis, pre-pandemic economy, economists generally pegged the neutral rate at 2%. Neutral refers to the rate level that should neither stimulate nor slow the economy.

Powell still believes the current short-term rate interest target is restrictive. He also recently said the neutral level is probably much higher than the previous 2% consensus. Yet, it’s not yet clear what he believes that higher rate will be.

The Fed chair also emphasized that future policy, including market expectations for a December rate cut, remains data-dependent. Policymakers are prepared to adjust their pace and path according to labor market and inflation data. Additionally, he noted that election results won’t have a near-term effect on Fed policy.

Fiscal Uncertainty May Shape Future Fed Policy

In our view, the election results give Trump a clear mandate to address immigration, crime and cost-of-living challenges. But we’re not confident the mandate extends to enacting major new tax cuts or significantly increasing the deficit. Even if Republicans control Congress, we expect some pushback on any major fiscal policies that would expand the nation’s debt.

Of course, Trump can impose tariffs without congressional approval. Tariffs on China are likely, but others aren’t and may include exemptions for certain goods and countries.

We don’t believe the inflationary impact of tariffs is as straightforward as the market currently fears. Ultimately, they may end up restricting demand and slowing down consumption rather than igniting inflation. Given these uncertainties, we expect the Fed to pursue a wait-and-see approach rather than a specific course, leaving room to pivot if necessary.

Treasury Market Moves Underscore Fixed-Income Opportunities

Fears that interest rate policy was too restrictive given moderating inflation and labor market weakness prompted the Fed’s unusual half-point rate cut in September. But since then, renewed hopes for strong, sustained growth, which weren’t prevalent before the September rate decision, thrust the benchmark 10-year Treasury yield higher. Instead of tracking the federal funds rate lower, which often occurs, Treasury yields have climbed.

For example, between the Fed’s September 18 rate cut and November 4, the yield on the 10-year Treasury note surged 0.61%. This massive move, illustrated in Figure 1, marked an unusually large increase in the 10-year Treasury yield following a Fed rate cut.

Figure 1 | 10-Year Treasury Yield Soared After Fed’s Half-Point Rate Cut

Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity, Quoted on an Investment Basis

Line chart showing the surge in 10-Year Treasury yields following the Fed’s half-point rate cut from September to November 2024, illustrating market volatility.

Data from 9/18/2024 – 11/4/2024. Source: Federal Reserve Bank of St. Louis.

What does this mean for investors?

In our view, the Treasury market’s significant and swift move has created opportunities in the bond market. As we’ve outlined previously, yields on cash-equivalent instruments typically track the federal funds rate. This means the yields you’ve been earning on CDs, savings accounts and other cash equivalents will likely decline as Fed easing persists.

This dynamic highlights the rise in reinvestment risk or the inability to reinvest future cash flows at the same yield you’re currently earning. But, in today’s yield environment, there are opportunities to manage reinvestment risk.

Shorter Duration, Income-Focused Strategies Help Confront Interest-Rate Risk

Shifting cash-equivalent holdings into higher-yielding assets is a strategy that often gains favor when the Fed is cutting interest rates. In today’s market, Treasury yields have shifted notably higher across most of the yield curve, providing potentially attractive entry points. As bond yields rise, bond prices generally decline.

Meanwhile, the timetable for future Fed rate cuts remains unclear. Inflation, employment and Trump administration initiatives will likely influence the Fed’s course, potentially triggering continued market and interest-rate volatility.

In our view, short-duration strategies offer potential yield and total return advantages while reducing exposure to interest rate volatility. Within this duration framework, we also believe higher-quality bonds with potentially attractive yields may help weather this changing backdrop. Such securities include U.S. Treasuries and higher-credit-quality corporate and securitized bonds.

Authors
Charles Tan.
Charles Tan

Co-Chief Investment Officer

Global Fixed Income

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In certain interest rate environments, such as when real interest rates are rising faster than nominal interest rates, inflation-protected securities with similar durations may experience greater losses than other fixed income securities. Interest payments on inflation-protected debt securities will fluctuate as the principal and/or interest is adjusted for inflation and can be unpredictable.

Generally, as interest rates rise, the value of the bonds held in the fund will decline. The opposite is true when interest rates decline.

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