Finally! The Fed Front-Loads Rate Cuts

Today, the Federal Open Market Committee announced a cut of 50 basis points (bps; 100 bps = 1.00%) in its key interest rate, the federal funds rate, lowering the rate to 4.75–5.00%. A cut of at least 25 bps was widely expected based on recent inflation progress and economic data, and it was broadly welcomed as a sign that yes, this lengthy era of high interest rates will eventually end. We believe the Federal Reserve (Fed) will continue to cut rates two more times this year to support economic growth—though in smaller 25-bp steps rather than jumbo 50-bp ones.

The rate of inflation clearly has improved over the past few months. The Fed’s preferred measure of prices, the Personal Consumption Expenditures (PCE) Price Index, has continued to fall. Although the core PCE Price Index (excluding food and energy) remains slightly elevated, we believe enough progress has been made given the current growth backdrop (robust, though with a weakening trend).

The key data we’re monitoring is the labor market—the main challenge for the U.S. economy moving forward. The U.S. unemployment rate, which has steadily increased in 2024, ticked up to 4.1% in June. Forward-looking growth indicators for the U.S. manufacturing sector remain weak, and while the services sector is still growing, it’s at a slower rate compared with earlier in the year.

Our base case is that the Fed will cut in each of its last two meetings this year in order to support gradual slowing of the U.S. economy. We also expect the Fed to remain vigilant in monitoring inflation as the fight might not be over just yet. Beyond 2024, the interest rate market is already pricing in more rate cuts, all the way until May 2025. However, this seems to us to be on the higher end—we expect growth to soften but do not foresee an outright U.S. recession.

We continue to favor bonds, which benefit from moderating growth and moderating inflation, particularly internationally. We also continue to like equities—especially the cheaper parts of the U.S. equity market (excluding mega-cap U.S. technology equities). We expect the equity rally to broaden and believe that any relief from perceived looser monetary policy would likely support equity prices in the medium term.

Upcoming U.S. elections and ongoing geopolitical uncertainty will keep markets more volatile, and we expect the Fed to take these developments into account.