Key Insights to Navigate the Fed's New Easing Cycle

Understand the economic context. To understand the implications of the Fed cut, it’s important to first note why they made the move. The Fed has been attempting a highwire balancing act of maintaining economic growth and achieving a soft landing, while reining in inflation. Indeed, the rate of inflation has been slowing in recent months. However, too much stimulus resulting from a rate cut could reignite it.

In the end, concerns about slower economic growth won out. Unemployment is starting to tick up, and there are other signs that the economy is slowing.  The fact that the Fed cut by 50 basis points, rather than 25, highlights that they consider a stalling economy to be the bigger risk versus inflation picking back up. It is important to remember that during the 2006-07 rate cut cycle then Fed Chairman Ben Bernanke (in hindsight) was criticized for doing too little, too late, which is probably something current Chairman Jerome Powell wants to avoid. If you win the war on inflation but it costs the US a recession, did you really win? 

As always, keep an eye on economic data to see if the Fed got the timing (and size of the cut) right this time. The Fed has commonly cited two main drivers in interest rate decisions and economic outlook: the employment rate and inflation.  It will be important to follow both closely in the months ahead to see whether the Fed will follow with additional — and larger — cuts. 

History can be a guide — sort of. Investors understand that past performance does not predict the future, but history can still reveal a great deal. The Federal Reserve has now launched nine easing cycles by lowering interest rates since 1980, including the current one. Each of those cycles took place in unique macroeconomic environments, some with rising inflation or unemployment data, rising and falling GDP or other data. In general, high-quality bonds like US Treasuries and investment grade debt, have performed well on average, as the chart below shows. 

Fixed income is still attractive – especially if volatility spikes. Can history be repeated then and bonds outperform stocks over the next six to 12 months? Predicting market returns in the near term is fraught with peril, and we are by no means suggesting abandoning equities. In fact, we believe investors should consider well-paying dividend stocks, to help boost income streams as a buffer against volatility.  But history is not the only reason to favor tilting towards higher allocations of bonds.

To begin, it is important to remember that bond yields are still high relative to recent years. Yes, they are likely to grind lower in the months ahead, but we are likely to still be far from the “low for longer” period following the 2008 Financial Crisis.  In addition, as is the case with dividend stocks, finding stable income – especially when yields are decent and above the rate of inflation — is also appealing, helping to create a buffer against volatility.

Finally, bonds have long played a vital role in portfolios as potential safe havens and diversifiers from equity volatility. They may be called on to play this role again, given the historical patterns of equity volatility and the upcoming elections, as we discussed recently.