Fed to cuts rates again in November – heightened US election-related bond market volatility to be expected

Fed to cuts rates again in November – heightened US election-related bond market volatility to be expected

Comments by Michael Krautzberger , Global CIO Fixed Income at AllianzGI, ahead of the Fed meeting on 6 and 7 November 2024

Fed to cuts rates again in November – heightened US election-related bond market volatility to be expected

  • We expect the US Federal Reserve to cut rates by 25bp at its 7th November policy meeting, taking the target range for the Fed funds rate to 4.50-4.75%.
  • US economic data has generally surprised to the upside since the September policy meeting, while a rising probability of a Trump victory in the US Presidential election has also contributed to the recent bond sell off.
  • Monetary conditions have now taken out quite a lot of easing in recent weeks given the re-pricing in both front-end and long-end rates and given the stronger US dollar.
  • We believe that the Fed still wants to move towards a more neutral policy stance as its confidence grows on the inflation outlook. Interest rate markets are almost fully pricing a 25bp rate cut at the November meeting and pricing around a 60% probability of a further 25bp cut in December. We broadly agree with this pricing.
  • The outcome of the US election could be the biggest disruptor to market pricing of the Fed easing cycle in 2025; we expect further near-term volatility in bond markets as investors digest the policy implications of the election result.
  • We think the best way to express the current macro and policy backdrop in our portfolios is via US (and euro) yield curve steepeners, albeit we tactically reduced curve risk during September. We will also look for opportunities to add duration risk opportunistically on any further back up in US Treasury yields or add duration in other G10 bonds markets which have the shallowest interest rate cutting cycles already discounted in forward markets.

The Fed surprised market expectations in September, with a larger than expected 50bp rate cut to start its rate cutting cycle. The Fed signalled an important shift in its policy reaction function, with a renewed focus on the employment portion of its dual mandate. Although trends in the labour market data still present a broadly constructive backdrop for the US economic outlook, the Fed’s policy shift – towards pre-emptive, “insurance” rate cuts – suggests policymakers are alive to the risks of keeping policy restraint in place for too long, unnecessarily raising recession risks in 2025.

The Fed’s dot plot projections from the September meeting showed a median forecast of a further 50bp in cuts for the remainder of this year and a further 100bp in 2025. Forward interest rate markets have moved to broadly mirror this outcome, with a terminal rate in this cycle around 3.5%.

The Fed’s actions have for now at least raised the probability of a US soft landing in 2025, even though history tells us that this is a rare outcome.

US Treasury yields have responded to this favourable set-up for the growth outlook in 2025, with 10-year US Treasury yields rising by some 55bp since the Fed cut rates on 18th September.

However, any sharper than expected slowdown in the US economy in 2025 versus current expectations would leave room for the market to price more aggressive cuts and a lower terminal rate. We think there is scope for hard landing probabilities to rise – but this hinges on the extent of any labour market deterioration ahead.

In the short term, we prefer to be positioned for steeper yield curves in the US given that the easing cycle is now underway and long-end bonds still face the challenges of huge fiscal deficits and the potential uncertainties around inflation after the election.

We may look to opportunistically add duration risk on any further back up in bond yields, although we think yield volatility is likely to stay elevated over the near-term.


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