Bond Watch: US rate cut on the cards, but too early for UK decision

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors. 

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors. 

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Here’s what you need to know this week. 

US Federal Reserve indicates three rate cuts next year

The American central bank held rates steady at between 5.25% and 5.5%, but chair Jerome Powell gave investors his most dovish message yet.

Powell said that it was “likely at or near its peak for this tightening cycle” and the forecasts for rates next from his team showed the consensus was 0.75 percentage points of cuts.

Bonds and stocks rallied at the news, with yields on the US 10-year bond dropping from 4.2% to around 4%.

Charles Hepworth, investment director at GAM Investments, said: “This was a more dovish projection than most expected ahead of the meeting and further acknowledgement that we are now firmly post peak rates.”

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Annual inflation in the United States for November dropped from 3.2% to 3.1%, in a fresh sign that inflation is under control and is heading towards its central bank’s target of 2%.

However, “core” inflation, which strips out volatile items like food and energy, remained flat at 4%, showing that the Federal Reserve cannot relax just yet.

The encouraging inflation figures would have informed the central bank’s decision to hold interest rates steady at 5.25% to 5.5%, suggesting that a healthy economy and stable inflation numbers meant that they did not need to act to control prices or stimulate growth.

UK economy stalls and rates held at 5.25%

The Bank of England left interest rates unchanged and governor Andrew Bailey warned there was “still some way to go” to hitting the 2% inflation target.  

The hawkish message sent sterling and bond yields higher, as investors bet that interest rates would be higher for longer.

Hugh Gimber, global market strategist at J.P. Morgan Asset Management, said: “Christmas came early for risk assets yesterday with the Federal Reserve’s dovish turn. Unfortunately for the Bank of England, economic data in the UK means that policymakers simply aren’t able to be as generous.

"With wage growth still above 7% and headline inflation north of 4%, it’s too early for the Bank to declare victory in its battle against inflation.”

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Hepworth adds that three of the nine committee members voted for an increase in rates by 25 basis points to 5.5%, which corroborates Governor Bailey’s vocal message that there is still some way to go in the fight with inflation. 

“In forecasts for next year, rate cuts are being pushed a bit further out given this less dovish messaging compared to the Federal Reserve last night. Roughly, a one percentage point cut in rates is still the expectation by the end of next year.”

In other news this week, UK gross domestic product fell 0.3% between September and October. Economists expected a 0.1% drop in GDP, after the economy grew 0.2% in the previous month