Top of the Morning: CIO Strategy Snapshot - What’s next for rate cuts?
The desk believes that last week's FOMC rate cut, accompanied by modestly improved economic projections, signals a favorable environment for equities and a cautious optimism around further monetary easing. Per the full note source, while the rate adjustment was anticipated, the Fed's GDP growth and inflation forecasts for 2026 were notably revised upwards, suggesting more robust economic conditions than previously projected. This sets the stage for traders to position themselves for potential further cuts. Given the current economic trajectory, the desk maintains a positive outlook, although broader market volatility remains a consideration.
What the desk is arguing
The desk frames this as an inflection point where improving economic indicators may support continued equity market strength alongside expanding expectations for additional rate cuts. Jason Draho from UBS highlights that the Fed's projections for GDP growth and unemployment have shown a healthier outlook, contributing to a constructive narrative for risk assets.
The current landscape reveals that the Fed is responding to a slightly more favorable economic situation, where inflation remains in check and unemployment is not rising as expected. This nuanced pivot aligns investor sentiment, driving the S&P 500 to new highs post-rate cut, indicating robust investor confidence.
Where it sits in our coverage
Our consensus target for major currencies suggests a central position around 1.075, with range estimates spanning from 1.04 to 1.12. Specifically, jpmorgan has established a target of 1.10 for March 2026, whereas bofa is on the lower end, projecting 1.04 for the same tenor.
Given this information, the desk's optimistic stance reflects some divergence from the lower end of the projected spread, positioning it at the higher mark of expected outcomes.
How other firms see it
Firms like jpmorgan and credit suisse are aligned with this positive view, reflecting a consensus towards potential market growth bolstered by expected rate cuts. However, bofa appears more cautious, projecting a conservative outlook that suggests potential resistance to any further rate reductions.
The dynamic between the USD and JPY could also be influenced by these shifting Fed policies, particularly as traders watch for the Fed's forthcoming communications around rates and inflation expectations.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Last week's FOMC rate cut reflects positive economic adjustments.
- 02Revised growth and inflation forecasts bolster confidence in equities.
- 03The S&P 500's response signals strong investor sentiment following the rate cut.
- 04Future positioning should consider potential continued cuts amidst market optimism.
Market implications
Traders should watch the S&P 500 closely, particularly for movements above recent all-time highs to gauge market momentum. Additionally, with no imminent high-impact events scheduled, shifts in Fed commentary or economic data releases will be crucial indicators moving forward.
Risks to this view
A more hawkish stance from the Fed than currently expected could quickly invalidate the optimistic outlook. Key economic data, such as a rise in unemployment or sharp inflation increases, could lead to a reassessment of the Fed's path and potential rate cuts, impacting equity and FX positions.
Hi everyone Dan Cassidy here welcome back to top of the morning on the UBS market moves podcast channel of the Fed cut rates last week as was widely expected and while investors are uncertain about the ultimate path of rate cuts from here are they certainly reacted positively to the cut last week the S&P 500 continued its grind higher setting more new all-time highs the calendar is quieter this week but the state of the economy and Fed policy will remain in focus so a joining me here at the table this morning to discuss this all glad to welcome back Jason Draho head of asset allocation for the Americas with the UBS chief investment office Jason thank you for dropping by on this Monday morning nice to be back with you good morning Dan happy Monday yeah good to be back in the studio this time and the first day of fall I might add so we've made you had to remind me okay so with that Jason a lot to cover let's of course begin with that 25 basis point that rate cut last week and the rationale behind that cut what is your takeaway from the decision last week well let's just sort of summarize what the Fed actually did you know you're cutting 25 basis points everyone you know it's that hopefully at this point in time there was updates to their economic projections which were maybe a little bit surprising because not so much for this year because 2025 we're three quarters the way done so you're not going to change much but for 2026 they took up both their GDP growth forecast you know marginally their inflation forecast but also took down the unemployment rate so overall a little bit better macro picture today or as of this Fed meeting versus June which makes sense as we've moved forward three months the economic data is held up a little bit better than kind of a you know expected inflation hasn't risen quite as much unemployment hasn't risen quite as much I think they're kind of just marking to mark yes to some extent but it wasn't kind of noteworthy that in general relative to what it was before it's a slightly kind of reflationary tilt to the prior forecast something else I got a lot of focus was you know the dot plot where the FOMC members 19 of them submit their dots of how much they think rates will be cut ultimately this year in total 2026 you know 2027 as of June the median dot of the members was you know two cuts in total this year well we got one in September so that would have implied one more the median dot now is is not three it was a little bit split you know there were nine members who were at three cuts in total this year so I'm applying two more nine members had two or less in total meaning they'd expect one more or no more the rest this year there was one outlier we don't know if 100% certain but it's like 99.9% certain that I was Stephen Moran's dot he just joined the Fed like literally for that meeting appointed by President Trump earlier summer his dot applied six cuts in total this year there was not much 20 25 in 2025 so basically three 50 basis point cuts which you know when there was a dissent there's only one dissent it was Marin and he basically said he wanted 50 basis points of cuts this time in July there was two members Chris Waller and Michelle Bowman who had sort of dissented thought they should cut then now they were in line with that with that view so a little less maybe dissent you know overall in terms of what they did and why they did it to Fed Chair Jay Powell did mention during the press conference that you know the downside risks the labor market you had increased similar to those comments he made back at the end of August at the Jackson Hole Central Bank Symposium and basically he made the point that the labor market demand seemed to have slowed more than labor market supply and that was you know the rationale the Fed doesn't want to see the labor market demand slow any further ultimately thing is that the way that Powell framed that is a bit of a risk management cut and there's different ways to you know people sort of interpret what those words mean so not necessarily signaling this is the start of ongoing cuts but some people would interpret as like risk management means we want to get back to sort of neutral and neutral you know relatively quickly which will imply more cuts you know coming you know you know our takeaway is it you know what happened is sort of roughly in line what we expected a 25 basis point cut now we expect going into the meeting for consecutive 25 basis point cuts so another one end of October mid-December end of January and the guidance from the Fed will certainly be consistent with that view for 2025 I think you know next year in beyond it's becomes a little more uncertain most definitely more uncertain of what path the Fed will take so from hearing that Jason the big question now is what comes next for rate cuts for the balance of 2025 and of course into 2026 so what are your expectations from the chief investment office Jason I always like to start with like what is the market pricing and you know where would we maybe deviate from that current market pricing is that there'll be four cuts basically in total by the end of July and by the end of December of next year the Fed funds rate would be about 2.9% which implies five and a half ish cuts you know from the current level look as I said we expect cuts the next you know three meetings after that I think we you know another cut some point next year but it really becomes so you know data dependent I think there's a good chance the Fed does a hundred assesses where things are and then sort of you know maybe you know move to a quarterly pace one more cut maybe maybe two more cuts it's something like that the key thing is though there's pretty good consensus and you know reason you know good reason for for that consensus to cluster around the fact that we'll probably get two more cuts this year if you look to 2026 though the consensus is well there's almost no consensus it's very wide kind of you know dispersion of views and you can see it in different ways go to the dot plot I mentioned like you know it's kind of split so you know how much we're gonna get this year if you look for next year it is a really wide range of outcomes you know of how much the Fed would cut next year and where the Fed funds rate will end up by December of next year at the low end are people who are expecting you know the Fed funds rate to be like two and a half to two seven two point seven five percent at the high end basically between three and three quarters three point seven five percent and four percent so a hundred and twenty five basis point range and if you look at the number of dots at each sort of 25 basis point interval it's almost uniformly distributed not quite but it is there's there's not clustering in a couple extremes it is kind of a pretty broad based I think it which again reflects the fact that low conviction on exactly how things will play out next year whether inflation could reaccelerate whether the economy could really tip into a more severe global slowdown whether inflation just ultimately kind of moderates on its own I think market pricing similarly reflects this broad dispersion we think about a year from now where's the Fed funds rate you know it's kind of centered around like three to three and a quarter but again a range a pretty like flat distribution of outcomes of where the Fed funds rate will be so low consensus for next year the the market implied sort of or a measure of the market implied Fed fund neutral rate is also lower more like three and a quarter to three and a half percent ultimately I think what will matter beyond the next two probably three cuts into early January the path and ultimate destination for the Fed funds rate is going to pin down number of factors like economic data how it actually plays out and the sensitivity of the Fed to that data clearly the Fed right now is sensitive to labor market weakness and so if you we get a week's job report for September that is negative for example you know or a couple of months where we are you know running around zero decent chance the Fed ultimately then pulls forward some cuts from next year to maybe cut 50 basis points if not a cobra then then by December you know just for perspective and we know the labor market is cooled on the last three months the headline payrolls growth for non-farm payrolls was 29,000 on their three-month average if you strip out the health care and social system over the last four months it's minus 36,000 so again sort of softness in the labor market that would warrant especially there's any further weakness perhaps in acceleration ultimately of course what is the Fed's approach to policy what level are they comfortable with in terms of how they balance the risks between you know growth labor market and inflation I would have said even a year ago we were discussing that the Fed there's a bias towards a lot of the Fed allowing the economy to run hot meaning it tolerate inflation to get back to 2% very very gradually which is implicitly almost tolerating an inflation target of 2.5% to 3% in order to keep nominal GDP growth higher you run the economy hot you keep the labor market strong also looking at the you know the fiscal situation if you're running a deficit of 6% plus of GDP if you can have nominal GDP growth of like 5% or higher that at least kind of stabilizes the situation or slows on you know over time from a nominal perspective how the debt problem becomes high so I think there's a natural bias for the Fed towards something along this these lines you know also another factor in terms of how much the Fed will cut is like what is neutral like how much does the Fed need to cut we can estimate it we know we can't actually observe it there's also a real debate you're tied in like well if you get faster productivity growth all sequel that means a higher neutral Fed funds rate which means the Fed needs to cut less all else equal that ties in very much with AI how is this being dispersed how it's having an impact on the overall growth rate of the economy and the productivity we still early on that but again as the next six months year goes on we'll get better clarity so all this is to say a lot of uncertainty for the path of next year a lot of factors underlying structural trends the actual economic data near term how it plays out what we expect as I mentioned three more cuts and I think we have pretty good confidence in that beyond that probably one more for next year but I think the path is very sort of you know data dependent so Jason running with this a bit further you mentioned that the path and final destination for the Fed funds rate will matter for markets how so exactly well right now it's it's close a lack of consensus that I mentioned it was a lack of consensus it means the market narrative of how many cuts the market pricing for how many cuts can shift a lot based off of a couple of months of data so things can move around a lot we've seen this for the past couple years we're two months of inflationary data suddenly the market believes one thing and then two months of disinflationary the market believes something else and you kind of need a pivot around that so low conviction means just more subject to sentiment shifts in terms of how things will play out and that just means ultimately market pricing and performance will also oscillate with it right now the markets generally believe that the Fed will be able to kind of thread the needle meaning cut rates stabilize the growth so maybe moderates a little bit but ultimately kind of accelerates next year it doesn't lead to inflationary impulse there's a tariff one-time shock that will play out and by this time next year inflation will be clearly rolling over so you have a 2026 where growth should accelerate inflation comes down to the Fed is cutting rates like that's what the market the consensus view not a lot of margin for error if it turns out one of those data points you know upsets the Apple card and the Fed has to do something a little bit different so for example fewer cuts or slower pace of cuts you know you'd see rates go higher and there's some you know if you look at the market last week some thought that because Powell didn't give more guidance the back end of the curve the 10-year was up a little bit higher real interest rates the real 10-year yield was up you could also see if that happens if rates go higher some of the stuff that's been benefiting from rate cuts like small cap stocks maybe homebuilders that would also sort of unwind the dollar would probably strengthen more cuts a faster pace you know could have different implications rates likely go lower equities if it's a growth scare real growth scare you could see equities pull back but then if it's not a bad growth scare people buy the dip and then you see equities kind of in a rally so definitely you know kind of rotating potentially among market narratives of like Goldilocks reflation of the economy looks like it's gonna run hot stagnation if they get kind of gets it wrong and inflation picks up and growth slows so definitely sensitive to ultimately the end point of where the Fed is. So in terms of how to position in this environment and considerations when it comes to what's ahead of us let's end on asset allocation and the timing works well Jason because CIO last week published its latest house view update so can you close out by sharing with our listeners some of the key messages from this update? Well the total of the house view the monthly letter was investing as the Fed cut rates so it's very literal so you know what should you do like one of the key messages is that you know the bull market remains on tack and therefore a key message to kind of buy on dips and equities.
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