After eleven rate hikes since Feb 2022, bringing US interest rates to a 23-year high of 5.25 – 5.50 percent, the US Fed finally reversed course yesterday.

The 50 basis point rate cut represents the Fed's pivot into an easing cycle that is expected to last well into 2025, and sets the stage for a new economic and business era around the world.

Below are some of the many questions we have received about what this new era will look like, and what it means for short and long term investment opportunities.

Q1: What does the 50 bps cut tell us about the state of the US economy?

We take a neutral view of yesterday's cut which is deemed by some commentators as “more aggressive” than expected. In our view, it represents a confirmation that, even though inflation is not back to the Fed’s 2.0 percent target, it is getting close enough to where it should be in an expansion. As such, the Fed's inflation fighting period seems to be over for now.

Also, in our view, this rate cut is a mid-cycle adjustment rather an attempt to stave off a near term recession. Despite some weakening in US economic fundamentals, we do not think current data trajectories point to a recession in 2025. In addition, we believe that the Fed has transitioned its focus from inflation to growth and employment rates, given increased evidence of a maturing cycle in labour markets.

Q2: Markets failed to rally in response to the Fed's announcement. Where do you see markets going from here?

We updated last month following our Strategy Group meeting that we expect some temporary market volatility. Yesterday's market response to the Fed rate cut announcement seems to be part of this trend. Markets are concerned about slowing growth and there is a risk of over-expectation about the pace of cuts. We also note that both stocks and bonds have had a strong run so far this year, and could be due for a breather.

However, we think the combination of a continued expansion and a rate cutting cycle should be positive for markets over the medium term. Once the market adjusts to figuring out the new policy path, we expect any short term volatility to diminish and gains to accumulate. Furthermore, yesterday's Fed statement suggests a “Fed Put”, that is, the potential for the Fed to intervene to support growth, and rescue markets should prices fall too much,

Q3: How many rate cuts will the Fed make in 2024 and 2025, and where is the bottom?

A typical way to benchmark interest rates is to use the Taylor Rule, which uses a formula based on desired inflation and unemployment levels, and the Fed's view of what the neutral rate should be. The Fed's statement yesterday indicates around eight 25-basis point cuts by end-2025, whereas the Fed Fund Futures market suggests nine or 10 cuts, getting interest rates down to 2.75 to 2.5 percent.

Our calculations, assuming a 4.0 – 4.5 percent unemployment rate, core PCE of 2.0 – 2.25 percent, and a neutral rate of 3.0 percent, point to around six cuts. Given this, our forecast is for the Fed to make between six to eight cuts, causing the Fed funds rate to fall to 3.0 – 3.5 percent.

This level is higher than the current market consensus, but is consistent with our overall Higher for Longer thesis.

Q4: What does this mean for the bond market, and which bond sectors could benefit the most?

After interest rates have peaked and until they bottom, bonds will tend to see steady price gains and should be a good part of investors' portfolios. This is especially as cash rates could decline a further 1.0 – 1.5 percent over the near term.

While average bond yields will fall further in an easing environment, we would expect bond yields averaging 3.5 – 3.7 percent to continue to attract investor demand. Additionally, to lock in higher yields, there is likely to be increased interest in corporate, high yield and emerging market bonds. A structurally weaker USD will also help bolster local currency bond returns.

Q5: What does the rate cut cycle mean for equity markets?

We think global equity markets will return to positive returns after a period of heightened volatility. This is based on our analysis that markets tend to respond well to rate cuts, even against a backdrop of lacklustre or mildly negative growth

Since 1970, rate cuts in soft landing environments saw 19 percent average global equity returns over a 12-month period. Conversely, despite rate cuts, 12-month equity returns averaged -3.5 percent amid hard landing scenarios

Going forward, healthy earnings growth will be a substantial driver of global markets, even if growth moderates. However, the bar to achieve earnings estimates has risen. To meet these estimates, earnings growth will have to come from the broader market rather just than a select few.

Q6: Which other asset classes stand to benefit from rate cuts?

Real estate investment trusts (REITs) are widely seen as a key beneficiary of interest rate cuts. The cost of financing is a major drag on REITs' earnings and lower interest rates therefore mean greater profitability. Some REITs see a falling rate environment as an opportunity to grow their assets portfolio by making more acquisitions, which is ultimately positive for their market price.

Also, given the expectation of slower growth, investors may want to hedge against a full-blown recession. Gold is often an effective way to insure against recessions and the demand for gold has been steadily increasing. Gold prices today are almost 30 percent higher than they were a year ago.