At its highly anticipated September meeting, the Federal Reserve opted to kick off its rate cutting cycle with a 0.50% cut. They continued this path with a 0.25% cut in December, bringing the target rate to a range of 4.25% to 4.50%. In shifting from a tightening (increasing rates) cycle to an easing (cutting rates) cycle, the Fed acknowledges the inflation threat has moderated, and they are instead focused on the employment outlook. Our view is that the larger size rate cut in September and subsequent move in December likely “pulled forward” some of the 2025 cuts that the Fed had already signaled. Going forward, we expect rates will fall in 2025, but the Fed will be slower to move. In particular, they will want more confirmation that inflation remains under control.
Given how much rates have moved up over the past few years, investors can still earn a meaningful return on high quality bonds that is well above inflation. We have focused our focus on short-term bonds (generally those maturing within five years). We have also actively used bond ETFs with a targeted maturity date as a cost effective and easy way to build a high-quality diversified bond portfolio.
As mentioned previously, we are watching for the risk of rising volatility and rising fiscal pressures. Owning shorter maturity bonds will help to mitigate some of these risks while maintaining an attractive level of income.
