Bond Watch: should US interest rates really be much lower?

Inflation in America was 2.7% in the year to July, the same level as in June. This was below market predictions of 2.8%, and therefore boosted stock and bond prices around the world. 

Investors now expect the US central bank to cut rates at their September meeting. In fact, US Treasury secretary Scott Bessent told Bloomberg that he thinks US interest rates should be far lower than the 4.25% to 4.5% they are today. 

Bessent’s view is that there should be 1.5 to 1.75 percentage points of cuts, which would take rates down to around 2.5%. He even said he thinks there should be a 0.5 point cut in September.  

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Is this right? Not according to Bloomberg’s John Authers, who said that it was “breathtaking” that Bessent thinks rates should be so low in America. 

Authers said: “With the current effective fed funds rate at 4.33%, he is suggesting that it should be about 2.6%. Over the last 70 years, the rate has never been that low with inflation as high as it currently is (with the core reading above 3%).” 

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With Trump set to appoint a new Federal Reserve chair in May next year, and Bessent playing a key role in the selection process, it is likely that interest rates in the US will keep falling, which would be good news for bond prices, so long as it doesn’t stoke inflation. 

Dan Siluk, a portfolio manager at Janus Henderson, said: “The Federal Reserve will look through the noise in goods inflation and focus on the broader macro signals; labour market softness, consumer fatigue, and the risk that slowing growth could become deflationary over the medium term. This CPI print does not derail the case for a September cut, if anything, it supports it.” 

Deutsche Bank analysts say that a 0.25 point cut in September is now fully in bond prices, and investors now see a further 1 percentage point in cuts from September to next summer.  

UK economy grows more than expected 

The British economy expanded 0.3% in the second quarter of the year, putting it on course to be the second-fastest growing economy in the G7, according to Deutsche Bank. 

This was ahead of the 0.1% growth forecasted by economists, but behind the 0.7% GDP growth in the first three months of the year. 

Gilt markets were steady in response, with investors not expecting this reading to alter the Bank of England’s outlook on the economy.  

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However, Deutsche Bank said that underneath the surface of the GDP reading there was much to be desired as government spending was the biggest contributor to GDP growth: “Public consumption and investment shot up 2% on the quarter and was the largest contributor to GDP (adding 0.5 percentage points to quarterly GDP).  

“We also saw a further build up of inventories in spring as President Trump’s trade war began – stocks added 0.2 percentage points to GDP growth. And most surprisingly, net trade was also a positive contributor to growth, outpacing almost all expectations,” the group said.