SoundInsightN°21
Bonds
Equities
The Big Pivot
The long-anticipated shift in US interest rate policy has finally materialized. Following over two years of rising and historically elevated rates, a double rate cut now signals a pivotal moment, carrying substantial implications for capital markets.
At the beginning of 2023, the US market anticipated an interest rate reversal by year-end. However, strong economic growth and persistently high inflation shifted expect-ations. The Federal Reserve continued rai-sing rates until July 2023, ultimately holding the benchmark rate steady at 5.5% - the highest level since 2001. With the release of the Fed's cautious economic outlook in the September Beige Book, clear signs of an impending policy shift emerged. None-theless, the Federal Reserve surprised many by implementing a 0.5% rate cut this month, equivalent to two standard 0.25% reductions. Out of 113 economists surveyed, only nine had predicted such a move.
This double rate cut caught many market participants off guard and ignited wide-spread debate. Federal Reserve Chairman Jay Powell addressed the reasoning behind the decision during a press conference. Historically, cuts of this magnitude have been tied to recessionary periods (e.g., the dot-com bubble, the Lehman crisis, and the COVID-19 pandemic). However, the current inflationary environment is different.
Despite the rate cut, the official forecasts released alongside the decision do not suggest an impending recession. Inflation appears to be under control, and the labor market is stabilizing. This view is shared by many economists, with expected recession risk for the US over the next year dropping from 50% at the start of the year to 30%.
With the magnitude of this rate cut, the Federal Reserve is signaling a proactive approach to mitigating the risk of a significant economic slowdown, ideally addressing it before it becomes a larger issue. The markets have already priced in expectations for up to eight additional rate cuts by the end of 2025. As a result, businesses are already benefiting from lower borrowing costs, and default probabilities remain at historically low levels, providing crucial support, particularly for capital-intensive sectors.
These developments suggest a favorable backdrop for equities and higher-risk assets. Analysts are projecting broad-based earnings growth for S&P 500 companies in the coming year. While major tech stocks have driven much of the growth and returns in recent quarters, a significant portion of 2025’s earnings growth is expected to come from sectors outside of technology and communication. Hence, for value stocks, which experienced no growth this year, analysts are forecasting a growth surge of over 10% in 2025.
As a result, markets are currently pricing in an optimistic outlook: a stabilizing US economy aided by rate cuts, historically low credit spreads, cheaper financing for companies, and double-digit earnings growth. However, the August jobs report and several leading indicators suggest that potential disappointments cannot be ruled out. Given these factors, we are maintaining a neutral allocation between bonds and equities. Sensitivity to economic data will remain elevated ahead of the US elections, making a focus on quality and stability within portfolios a prudent strategy.
Appendix
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Datasource: Bloomberg, BofA ML Research