Wealth managers have for some months pondered the asset allocation implications of a cut to US interest rates. The Fed cut rates by 50 basis points yesterday. Economists and strategists give their reactions. 

On Tuesday, the US Federal Reserve made its first rate cut since the pandemic year of 2020, cutting rates by 0.5 per cent, or 50 basis points, and it has cut its forward rate predictions. 

“In light of the progress on inflation and the balance of risks, the [Fed] Committee decided to lower the target range for the federal funds rate by 1/2 percentage point to 4-3/4 to 5 per cent,” the US central bank said in its statement. “In considering additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks. The [Fed Open Market] Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities. The Committee is strongly committed to supporting maximum employment and returning inflation to its 2 per cent objective.”  

Under its new projection on rates, the median projection sees the policy rate ending 2025 in the range of 3.25 per cent -3.5 per cent, which is 150 bps lower than the current range and much closer to long-run neutral monetary policy estimates.

With a close-fought US presidential election due on 5 November, and the state of the economy a factor, the cut of such magnitude in mid-September was always going to catch headlines. Concerns about preventing the US tipping into a recession are one factor, perhaps; another is progress in pushing down inflation. In early August, some signs of economic cooling slammed stocks, including those of the “Magnificent Seven” big techs such as Nvidia, Amazon and Microsoft. (They have since recovered to some extent.) 

That interest rates were due to head lower had been part of wealth managers’ thinking, and a backdrop to their asset allocation, for several months. At last, the world’s most influential central bank has pulled the trigger. Here are wealth managers’ reactions.

Tiffany Wilding, managing director and economist, and Allison Boxer, economist, PIMCO
The Fed’s actions suggest that it saw a shift in the balance of risks around inflation and employment, warranting a faster adjustment towards neutral than many officials had previously thought. Historically, looking at Fed cycles since the mid-20th century, an initial rate cut of 50 bps has typically preceded or signalled a recessionary easing cycle – that is, a generally sharper, deeper, or more prolonged series of rate cuts aimed at bolstering a struggling economy.

We do not believe that the US economy is currently in recession; consumer spending remains resilient, and investment growth appears to be accelerating. However, as inflationary pressures subside, the Fed appears to be focused on ensuring that US growth and labour markets remain strong by aligning monetary policy with today’s economy – which looks much more “normal” now that the series of pandemic-related shocks that drove high inflation have largely subsided. We believe that the Fed is on a path to ease policy by 25 bps increments at each of its upcoming meetings. However, the Fed remains data-dependent. If the labour market deteriorates more quickly than expected, we expect the Fed to cut more aggressively.

Historically, intermediate-maturity bonds have tended to outperform cash during Fed interest rate cutting cycles. With the Fed starting with a bang, investors may benefit from locking into still-attractive intermediate yields. Bonds also offer hedging properties in the event that a harder landing prompts the Fed to cut rates more quickly.

John Velis, Americas macro strategist at BNY
The outlook from here is of course “data dependent” and the Fed will address policy on a “meeting-by-meeting basis.” We think that’s wise. We (and Powell on Wednesday) have argued that most of the increase in the unemployment rate over the last year or so was due to new entrants into the labour market not finding jobs at the rapid pace they had been in 2023, and not due to firms shedding workers. This is crucial, and key to staving off a worse deterioration in unemployment.

UBS Global Wealth Management Chief Investment Office
The Federal Reserve has been a latecomer to the global easing cycle. The European Central Bank has already lowered rates twice. There have also been reductions from central banks in Switzerland, Sweden, Canada, New Zealand, and the UK. However, Powell was keen to stress that the Fed had not waited too long, arguing that the US economy remained solid and the labour market strong. Despite a 50 bps first cut, he said, the committee was presently in “no rush” to bring rates down.

With evidence that inflation is coming under control, the Fed can now focus on supporting jobs and growth while curbing the possibility of a recession. We maintain our base case for 100 bps easing in 2024. As returns on cash are eroded, we think investors should consider investing cash and money market holdings into high-quality corporate and government bonds. These assets have recently shown their value, cushioning volatility in equity markets.

Seize the AI opportunity: We believe that equity gains will broaden out, with continued potential for growth stocks to rise further, particularly in the technology sector. Within tech, we expect AI to be a key driver of equity market returns over the coming years and recommend strategic exposure to this theme. Investors may use tech sector volatility, which could rise in the months ahead on cyclical and geopolitical risks, to build up long-term exposure to AI at more favourable prices.

Diversify with alternatives: Including alternative assets in a well-diversified portfolio can help investors navigate a shifting macro backdrop. We view alternatives as a strategic source of diversification and risk-adjusted returns. Hedge funds can help stabilise portfolios during stress and generate attractive returns when other asset classes struggle. Investing in alternatives does come with risks, including around illiquidity and a lack of transparency.

Jean Boivin, head of the BlackRock Investment Institute
Yesterday’s move was a surprise and could be positive for markets in the near term, but we think it raises the prospects of further volatility ahead, especially if growth and inflation don’t pan out in line with the soft landing in the Fed’s updated projections. And given what is an extremely uncertain outlook and the divided opinions before the Fed’s blackout period, the near unanimity [on Tuesday’s decision] is perhaps more surprising than the one dissent.

Fed Chair Powell did use the word “recalibration” to characterise the policy decision. That could be the word he points back to if the Fed pauses rate cuts and it becomes clear that this will not be a full-blown easing cycle. We still think that market rate cut expectations will ultimately be disappointed and the positive news will instead come from resilient growth.

Joost van Leenders, senior investment strategist at Van Lanschot Kempen
We had thought the Fed would start with a 25 bps cut. Starting the cutting cycle with more aggressive steps is usually reserved for times with elevated stress in the economy or on financial markets, such as the popping of the dot.com bubble in 2001 or the financial crisis in 2007. Currently, the economy seems on the way to a soft landing, the S&P 500 touched an all-time high just after the decision and credit spreads are low. We also think that this bigger step complicates the Fed’s communication going forward. Is 50 bps the new standard cut? If so, for how long and what if the Fed wants to dial back to 25 bps? The uncertainty about the path of rate cuts may remain for a while.

The market reactions to today’s [Wednesay’s] decision were mixed. Two-year yields initially fell by more than 10 bps but recovered after the press conference. Ten-year yields initially fell by 5 bps before increasing by 5 bps from the level before the press statement. The S&P 500 initially spiked to a new all-time high, but eventually showed a small loss from the opening level. We think there are two reasons. Firstly, although markets got what they wanted, the Fed does not seem willing to go along with the aggressive cuts which were priced for the rest of the year before this meeting. Secondly, the 50 bps cut can be interpreted as a compensation for a Fed that has fallen behind the economic cycle and is now concerned about the labour market.

Julian Howard, chief multi-asset investment strategist, GAM Investments
It is hard not to detect a whiff of unnecessary panic here. US unemployment remains at 4.2 per cent, which is low by the standards of the last three decades. The latest non-farm payrolls report was also fairly robust at 142,000 job additions for the month of August, with average hourly earnings growing at a 3.8 per cent clip year-on-year. Labour participation has been growing too, suggestive of a swelling labour market pulling in new workers. Retail sales have stabilised and confidence, as measured by the Michigan survey, has been on a rising trend since June 2022. All this suggests that the US economy looks set for the vaunted soft landing anyway, in turn implying that high interest rates were doing little to slow things down in the first place. 

Why so? Capital-intensive sectors of the US economy such as heavy industry have faded over time amid offshoring and lower labour intensity. And US stock markets are increasingly dominated by highly cash-generative technology businesses for whom high interest rates have been an added bonus rather than a headwind. So US consumers are less exposed to the constricting aspects of higher interest rates than they used to be.