Update Bonds: Fed cuts rates
The Federal Reserve's decision this week to lower rates by 25 basis points (bp) marks a pivotal moment in monetary policy. It is the first rate cut in decades that coincides with inflation remaining elevated above 3%. It signals a significant shift from the Federal Reserve’s earlier hawkish stance. While the move was widely anticipated, markets are already pricing-in two additional cuts in 2025, reflecting growing expectations of easing financial conditions. Despite this optimism, the backdrop remains complex, shaped by concerns over the Fed’s independence, political pressures and shifting asset allocations.
The 25 bp cut, described as a "recalibration," highlights worries over a weakening labour market, as recent data points to slowing job growth. However, the Federal Open Market Committee remains divided, focusing on unemployment, which is one element of its dual mandate, while inflation is the other. Hawkish committee members continue to prioritize inflation risks, while more dovish members emphasize economic vulnerabilities.
The Fed also made a subtle but important change in its policy language, with Chair Jerome Powell noting the rate modification as “taking into account further adjustments to the neutral rate” — a signal that further adjustments to the policy rate remain under consideration.
While Powell refrained from signalling a clear easing path, Wall Street’s excitement over rate cuts pushed short-term yields lower. Interestingly, long-term rates rose (steepening the yield curve), pointing to structural concerns about longer-term economic risks. Investors are shifting away from long-dated Treasuries toward alternative safe-haven assets like gold, which has seen a resurgence in demand.
The Fed's independence continues to face scrutiny amid political and legal challenges. A recent court decision allowed Fed Governor Lisa Cook to remain in her role — despite efforts by President Donald Trump to remove her. However, the Senate's confirmation of Trump ally Stephen Miran further tilted the FOMC towards a dovish bias, raising questions about the Fed’s long-term policymaking autonomy. If the perception of a compromised Fed solidifies, this could mark a pivot point for markets. The erosion of trust in the Fed’s independence is already reflected in asset allocation trends, with investors increasingly shifting from Treasuries to gold as a hedge against uncertainty.
While the Fed’s dovish tilt offers near-term relief, governance tensions and persistent inflation risks loom large. In this environment, a balanced approach to portfolio construction, such as a strategy combining high-quality bonds and selective equity exposure remains a prudent way to navigate these volatile times.