Global Fixed Income Strategy - September 2024


The Fed moves decisively down the path to neutral
Growth is close to potential in the US and inflation is now fully under control, in our view. That argues for the Federal Reserve (Fed) to start moving interest rates out of restrictive territory. Most estimates of the “neutral rate”, the interest rate at which the Fed is neither supporting nor holding back growth, are currently somewhere near 3.5% for the US economy. Determining the neutral rate is not an exact science, but clearly, rates above 5% should be a brake on the economy, and that level of rates is no longer appropriate.
Still, the 50 basis point rate cut that the Fed delivered on September 18 surprised markets. Typically, larger cuts come in the context of a growth slowdown or financial upset, and neither are the case here. In this case, the Fed is simply acknowledging that, in the current environment, they should be closer to neutral, and that they are a long way from neutral now.
The market reaction after the cut validates this view and upgrades the outlook for financial markets going forward. The US yield curve steepened, and credit and equity markets did well. A steeper curve and stronger risk asset prices are consistent with a macro view that implies less growth risk (less recession risk) and easy financial conditions. A soft landing with rates near neutral would likely be a very constructive outcome for markets. The chance of the Fed achieving such an outcome increases with this rate cut.