Update Bonds: US Fed more cautious regarding rate cuts
The US Federal Reserve cut its federal funds rate by 25 basis points to 4.5%. The cut came with a clear message that the Fed intends to slow the pace of interest rate cuts in 2025.
Fed Chair Jerome Powell admitted that it was a close call, given the Fed’s new economic projections and against the backdrop of resilient GDP growth and sticky core inflation during 2024. Over the last 12 months, the trend of US growth (1%) and inflation ( 0.5%) increased, with the Fed cutting rates by 100 basis points in 2024.
The bond market reacted by pricing-in just 25 basis points of cuts in 2025, representing a slower progression to lower rates and a broader tightening of financial conditions. We believe the Fed will face challenges in the first half of 2025. Our base case calls for no cut in January, but the US policy rate may still end 2025 at 3.5%, which could be seen as the Fed’s neutral level. We acknowledge that better inflation news or worse employment news would be needed to reach this level.
Ten-year US Treasuries are currently yielding around 4.50% and German Bunds around 2.27%. Given that the largest open government-debt market is US Treasuries, they are more determinant regarding the direction of the long-end of government bond yields.
In Europe, weak but still positive growth and steady cuts from the European Central Bank (which is on the road to normalisation) could keep European sovereign spreads contained. Still, longer-term US yields could fall modestly under a contained fiscal baseline, given that strong US growth appears priced-in to markets. For year-end 2025, we expect ten-year US Treasuries to yield 4.20% and German Bunds 1.45%. (When bond yields decline, bond prices rise.)
Roel Barnhoorn
