Allianz: Expects the Federal Reserve to cut interest rates by 25 basis points in November, with the U.S. election intensifying volatility in the bond market
Allianz expects the Federal Reserve to cut interest rates by 25 basis points at the policy meeting in November, lowering the target range for the federal funds rate to 4.5%-4.75%. Due to better-than-expected U.S. economic data and an increased likelihood of Trump's victory in the election, bond market volatility has intensified recently. The market has largely priced in the expectation of a rate cut, and Allianz believes that the outcome of the U.S. election will influence expectations for the Fed's rate-cutting cycle in 2025, recommending an investment strategy that takes advantage of a steepening yield curve in the current macroeconomic context
According to the Zhitong Finance APP, the Federal Reserve will hold a policy meeting on November 6-7. Michael Krautzberger, Chief Investment Officer of Global Fixed Income at Allianz Investment, expects the Federal Reserve to cut interest rates by another 25 basis points at the policy meeting, lowering the target range for the federal funds rate to 4.5% to 4.75%. Since the interest rate meeting in September, U.S. economic data has generally exceeded market expectations. Additionally, the rising probability of Trump winning the U.S. presidential election has further fueled recent bond sell-offs. Affected by the repricing of short-term and long-term interest rates, along with a stronger dollar, monetary conditions have tightened significantly in recent weeks, reducing the degree of easing space.
As the Federal Reserve's confidence in the inflation outlook continues to strengthen, authorities still hope to move towards a more neutral policy stance. Currently, the interest rate market has almost fully reflected the expectation of a 25 basis point rate cut at the November meeting, with a roughly 60% chance of another 25 basis point cut in December. Allianz Investment generally agrees with this market expectation.
Allianz stated that the outcome of the U.S. election may become the biggest variable for the market's expectations regarding the Federal Reserve's rate-cutting cycle in 2025. It is expected that as investors gradually digest the potential impact of the election results on policy, the bond market will face further volatility in the short term. In the current macroeconomic and policy context, the best investment strategy is to adopt a steepening deployment of U.S. and Eurozone government bond yield curves, although Allianz Investment strategically reduced curve risk exposure in September. Additionally, opportunities will be sought to strategically increase duration risk when U.S. Treasury yields rise further, or to increase duration in other G10 countries' bond markets, as these markets have shallower rate-cutting cycles and have already been reflected in the forward market.
The Federal Reserve made a significant 50 basis point rate cut at the September meeting, exceeding market expectations, and officially initiated a rate-cutting cycle. The authorities' policy response mechanism has undergone a significant shift, refocusing on the employment objective within its dual mandate. Although labor market data continues to support the U.S. economic outlook, Federal Reserve policymakers have recognized the risks of maintaining policy tightening for an extended period, thereby avoiding unnecessarily increasing the risk of a recession in 2025. The dot plot from the Federal Reserve's September meeting indicates an additional 50 basis point cut for the remainder of the year and a further 100 basis point cut in 2025. The forward rate market has largely reflected this outcome, with expectations for the terminal rate of this cycle at around 3.5%.
Currently, the Federal Reserve's actions have increased the likelihood of a soft landing for the U.S. economy in 2025, although historically, this is a relatively rare outcome. Since the Federal Reserve's rate cut on September 18, the yield on 10-year U.S. Treasuries has risen by about 55 basis points, reflecting market optimism regarding the economic growth outlook for 2025. However, if U.S. economic growth slows significantly more than expected in 2025, the market may further anticipate a more aggressive pace of rate cuts and a lower terminal rate. The risk of a hard landing has increased, but this will depend on the future weakness of the labor market.
In the short term, given that the U.S. easing cycle has begun, and long-term bonds still face challenges from massive fiscal deficits and inflation uncertainties post-election, Allianz Investment tends to deploy strategies for steepening the U.S. yield curve Although it is expected that yield volatility may remain high in the short term, there may be a strategic increase in duration risk when bond yields rise further