A new round of U.S. policy rate cuts

We expect the U.S. Federal Reserve (Fed) to start cutting rates by 25 basis points (bps) at its Federal Open Market Committee (FOMC) meeting on September 16–17. This meeting will also include an update to the FOMC’s Summary of Economic Projections (SEP). Investors’ focus will be on the policy rate outlook, as well as FOMC members’ views on the inflation threat from tariffs and the downside risk to economic growth.

The futures market is currently pricing in over two 25 bps cuts for the remainder of 2025, including one cut in September. By the end of 2026, market indications are for policy rates to fall by 125–150 bps in total from the current level of 4.25–4.50%.

Although we have yet to see the full impact of tariffs on inflation, there are two reasons for the Fed to start easing monetary policy, as hinted by Fed Chair Jerome Powell during the Jackson Hole Economic Policy Symposium.

First, there are growing signs that the job market is slowing down. The August non-farm payroll data came in weaker than expected with only 22,000 jobs added for the month, compared to the market consensus of +75,000 jobs. While the July payroll change was revised slightly higher, the June figure was revised to a negative number, indicating that the job market contracted for the first time since the pandemic. The unemployment rate also rose to 4.3%. Along with other job numbers released earlier in the week, such as the July JOLTS data on job opening (down) and layoff level (up), the Fed is dealing with a more cautious corporate attitude towards hiring. 

Second, the Fed is reviving the argument that the inflationary impact from tariffs should be a one-off event. Therefore, it should look beyond this when making monetary policy decisions. Meanwhile, recent inflation data also show slower inflation in rent and services, as well as falling gasoline prices. Hence, the headline inflation number remains steady.

What type of rate cuts are we looking at?

Exhibit 1 is a chart showing the 12-month asset returns after the first rate cut. For risk assets, such as equities and high-yield corporate debt, the context of the rate cuts matters. 2001 and 2008 were tough economic recessions with sharp market corrections. 2001 saw the bursting of the dotcom bubble, and 2008 was the Global Financial Crisis (GFC). Unsurprisingly, equity performance during these two rate cut cycles was poor.

For the other rate cut cycles, the Fed was dealing with a more moderate slowdown in the economy. This meant that the underlying growth momentum was intact, providing some cushioning to corporate earnings. Hence, the 12-month returns for equities were still generally positive.

The range of outcomes in fixed income returns was narrower relative to equities, reflecting their lower volatility. Naturally, a rate cut cycle implies lower U.S. Treasury yields and modest positive returns from capital gains. Nonetheless, the GFC saw negative returns from corporate credits (both investment grade and high yield) due to corporate balance sheet stress.

Overall, we expect this upcoming rate cut cycle to be more consistent with a soft-landing scenario. Household and corporate leverage levels are modest compared to pre-GFC levels.

Investment implications

This implies policy rate cuts in the months ahead should still be a supporting factor for risk assets, including equities and corporate credits.

For equities, we still see the need for a globally diversified, active allocation. Our medium-term view of a weaker U.S. dollar should support emerging markets and APAC markets, as we have experienced this year. Earnings growth is uneven across different markets and sectors. For example, the outlook for technology and communication remains positive due to global artificial intelligence development, led by the U.S. and China. A steeper yield curve in the U.S. and other developed economies should also benefit the financial sector.

For government bonds, short to neutral duration should benefit from lower policy rates, while the longer end of the yield curve could be held up by questions over fiscal sustainability and central bank independence. Since lower policy rates should help to extend the U.S. growth cycle, this should also help to keep default rates manageable and support high-yield corporate bonds. As mentioned above, a lower U.S. dollar can also help drive more international capital flows into emerging market fixed income.

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