Bond Watch: what investors should weigh up as rates are cut

Earlier this week (17 September), the Federal Reserve met the market’s expectations and cut interest rates by 0.25 percentage points to a range of 4%-4.25%.

This marked the first US rate cut in nine months and the closely followed dot plot chart implies more cuts are expected this year.

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The accompanying Federal Open Market Committee (FOMC) statement and Federal Reserve chair Jerome Powell in conference emphasised the moderation in growth of economic activity in the first half of 2025, as well as a weakening of the jobs market and a pick-up in unemployment (albeit still low).

That said, Powell acknowledged the challenge of above-target inflation (US CPI was 2.9% in August) and took the opportunity to highlight the economic uncertainty surrounding effects of government policy and potential for inflationary tariffs outcomes. The quarter-point cut reflects the FOMC’s tightrope between “downside risks to employment” and “upside” risks to inflation.

In the UK, the anticipated hold of interest rates at 4% (on 18 September) by the Bank of England came to pass with a quite convincing seven (hold) to two (cut) votes among members of the Monetary Policy Committee (MPC). This followed the announcement a day earlier of a steady CPI print of 3.8% year-on-year (a 0.3% increase in August). While high, this did not surprise but does threaten a stickiness that the bank is cautious to “squeeze” out.

Also agreed was an anticipated decrease in the pace of quantitative tightening going forwards. The MPC gave little away about the next steps in the monetary easing journey. The committee has to weigh the recent resurgence of inflation throughout 2025 with mixed economic growth figures, the unknown of November’s Autumn Budget and a labour market that shows some signs of weakening.

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As the Federal Reserve initiates its first cut of 2025 (anticipating more), and the UK holds (but following three cuts already in 2025), the downward trajectory of bank rates and the substantial term premium (effectively higher yields for longer dated bonds) could naturally make the likes of money market funds less appealing in terms of real return potential and may logically entice investors towards the higher yields on offer from longer dated bonds.

Another route might be to consider options such as short-dated enhanced income products, which generally offer more attractive yields but the trade-off is that a bit more risk needs to be taken versus money market funds that aim to deliver a cash-like return.

Overall, a balance must be struck. With question marks over growth and labour markets (and even added political pressure from US President Donald Trump in America), further UK/US rate cuts and declines in short-term yields are on the table for the rest of 2025.

But, it is key to remember that, on the longer end, higher yields across 20, 30-year gilts (around 5.3-5.5%) and US Treasuries (around 4.7%+) reflect in part a market pricing a good deal of negativity and uncertainty beyond those preoccupations Powell shared himself on Wednesday: high sovereign debt-to-GDP ratios (in excess of 120% and 100% for the US and UK according to the International Monetary Fund), runaway fiscal deficits with question marks over governments’ capacity to resolve these, enduring or even resurging inflation, and political fracture.