Bond markets await further cuts to Fed rates

Bond markets are pricing in further significant cuts in American interest rates, despite the 75 basis point cut by the Federal Reserve last week.

The chaotic reaction in global markets to the news suggested that the Fed’s announcement had not been anticipated.

“The move last week was a major surprise. They rarely move outside of scheduled meetings, and the scale of the move was also a surprise, the biggest since 1982,” says John McNeill, investment manager at Aberdeen Asset Management.

After the cut the Federal Funds Rate stood at 3.5%, but Simon Foster, UBS Corporate Bond UK Plus Fund capability manager at UBS Global Asset Management, says the bond market expects this fall to 3% by the end of the first quarter.

There is another Fed meeting this week so another cut could be imminent.

McNeill says that he would not rule out the Fed cutting rates to 2% or 2.25% by the end of the year.

“If we do see a 100 basis point cut in rates, market participants will become concerned about the inflationary impact it may have,” says Foster. In this environment he says long-dated US treasuries look expensive.

April LaRusse, director of F&C Asset Management’s government bond team, says that the bond market’s reaction to the Fed’s announcement should be a welcome surprise to financial markets.

“Normally interest rate cuts are a positive for the bond market but this hasn’t proved the case with this latest cut, which saw bonds selling like crazy. If the Fed is seen as moving effectively to stave off recession this would be bad news for bonds,” LaRusse says.