Fed easing hopes rise ahead of US data

Video: Data with Donovan: Jobs data and the Fed's next move (8 mins)
Video: TRIOs for 2026: CIO’s Delwin Limas on AI, power, and longevity (7 mins)
Video:Why gold isn’t the only commodity you need, with CIO’s Wayne Gordon (6 mins)

The S&P 500 edged 0.3% higher on Tuesday, helped by growing confidence about the prospect of a rate cut by the Federal Reserve at its policy meeting next week. The market is now pricing a more than 90% likelihood of a 25-basis-point reduction, up from around 25% just under two weeks ago.

The move comes ahead of a flurry of data today and through the rest of the week on US employment, business activity, and consumer confidence. Recent commentary from top Fed officials has continued to point to divisions over the timing and pace of rate cuts. In addition, the divide at the central bank about the end point for the fed funds rate is close to its widest since 2012, based on the number of different estimates by policymakers, according to Bloomberg. Market attention has also been focusing on the Trump administration’s pick to replace Fed Chair Jerome Powell, whose term ends in May.

But despite the uncertainty, we continue to expect a steady pace of rate cuts, with two more by the end of the first quarter—creating a positive backdrop for quality bonds.

Upcoming data on the labor market looks likely to reinforce the case for easing, while inflation data shouldn’t stand in the way. While delays in data collection resulting from the recent government shutdown mean the scheduled official jobs report won’t be released ahead of the Fed meeting, investors can expect guidance from the ADP report, which monitors private sector payrolls. This series has recently pointed to cooling demand for labor, consistent with indications from the Fed’s Beige Book survey of regional economic conditions. The unemployment rate in September rose to the highest level in nearly four years. There have also been recent indications of weaker consumer confidence, with sentiment for November falling to its lowest level since April amid job and economic concerns. So, investors will be looking at the University of Michigan survey of consumers on Friday for an update. Finally, although inflation is running around 1 percentage point above the Fed’s 2% target, the personal consumption expenditure index—the Fed’s favorite measure—should show on Friday that price pressures are not intensifying.

The balance of views on the Fed continues to point to cautious easing, with the choice of a new chair unlikely to significantly change the outlook. Investors currently view Kevin Hassett, the director of the White House National Economic Council, as the front-runner to replace Powell. While Hassett has been a proponent of swifter rate cuts, we wouldn’t expect a pronounced shift in Fed policy. The chair is only one of 12 voting members on the rate-setting committee. In addition, concerns over the cost of living appear to have contributed to the weaker performance by Republicans in the 4 November gubernatorial elections and the mayor's office of New York. This has the potential to soften calls from the administration for an acceleration of rate cuts—though the preference will remain for growth-boosting rate cuts, in our view. The bottom line is that a cautious pace of easing—balancing the risks from inflation and to a weaker labor market—is our base case.

The prospect of financial repression supports our view that government bond yields can move lower. In our recent Year Ahead, we highlighted the challenge from rising government debt around the world. The International Monetary Fund (IMF) estimates the G7’s gross government debt to reach around 126% of GDP this year, up from 85% two decades ago. While this has the potential to increase the cost of government borrowing, especially on longer-duration bonds, we expect governments—including in the US—to manage this risk through further financial repression. This involves managing demand for government debt through mechanisms like bank, pension, and insurance rules, as well as central bank purchases, to keep rates under control. Against this backdrop, we expect the yield on 10-year Treasuries to fall from around 4.08% at the time of writing, to around 3.75% by mid-2026.

So, we are positive on quality bonds, specifically high grade government and investment grade corporate bonds. Medium-duration quality bonds (four to seven years) should deliver mid-single-digit returns from a mix of yield and capital appreciation as the Fed cuts rates, in our view. Bond returns look set to exceed cash rates, based on our forecasts, especially in adverse scenarios where bond prices rise as rate expectations fall. We see quality bonds as part of a broader investor strategy to ensure diversified sources of income.

For more detail on Fed policy, please read "Potential policy pivot" published on 2 December by Jason Draho.
On financial repression, see our "Year Ahead 2026: Escape velocity?" published on 20 November