How Rate Cuts Will Impact the Treasury Market: 3 Questions With an Analyst
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After holding interest rates at decades-high levels for more than a year, the Federal Reserve is expected to lower rates at its September meeting—a move that will have implications for the Treasury market. The interest you can earn on a Treasury, its yield, rises and falls based on economic and market conditions. Typically, investors look to earn more interest on longer-duration bonds because their capital won't be available until the maturity date.When that dynamic flips and the yield curve inverts, it signals that investors expect longer-term interest rates to decline. The yield curve has been inverted for more than two years, but economists say that will change as the Fed's Open Markets Committee (FOMC) cuts its influential fed funds rate.Investopedia spoke with John Canavan, lead analyst at Oxford Economics, about what investors can expect from the Treasury market if the Fed begins cutting rates. The interview has been edited for brevity and clarity.INVESTOPEDIA: What do you expect an interest rate cut in September will do to Treasury yields?JOHN CANAVAN: A lot of that will depend on the size of the interest rate cut and what the Federal Reserve tells us about forthcoming interest rate cuts after that.We expect a 25-basis-point rate cut in September and likely a total of just 225 basis-point rate cuts this year. If it occurs the way we expect, you'll need to see a little bit of a correction in the curve.You'll need to see a little bit of a correction in yields, meaning that front-end yields are probably a little too low over the near term. As it becomes clear the Fed will not ease as much as markets have priced in, front-end yields may need to nudge a little bit higher, thereby flattening the curve.INVESTOPEDIA: If the Fed continues a cycle of rate cuts, what strategies should fixed-income investors follow?JOHN CANAVAN: We do expect that inflation will remain calm and the economy will remain strong enough to allow the Federal Reserve to continue cutting rates throughout the course of next year. While we think there's some room for a little bit of a move higher in yields over the near term to adjust for the near-term Fed outlook, we do think that the broader outlook for Treasurys will be for a larger, long-term bull steepening that is front end.Yields will, over the course of 2025, continue to decline as the Fed continues to cut rates, and that will outpace any gain in the long end.So we still think that beyond the upcoming FOMC meeting, and over the longer term, there is still good value, in particular in the front end of the curve—say, the two-year to five-year, or the two-year to seven-year note area—which should continue to outperform as the Fed continues to cut rates over the course of next year.INVESTOPEDIA: What should equities market investors look for in Treasury-market trends during a rate cut cycle?JOHN CANAVAN: It's going to be positive for equities. Again, we believe that the economy will continue to grow at a modest but healthy enough pace throughout 2025. We did not forecast recession.At the same time, rates will be declining, which will allow companies to borrow money at more and more reasonable costs. It will also allow them to potentially refinance some of the higher-yielding outstanding debt that they're holding. So I think over the longer term, this should continue to be a positive for equities.Equities have obviously bounced back toward their recent record highs. The degree to which we continue to see new record highs over the next year, I'm uncertain. We could be in for a period of a sort of bullish range trade that is holding near the highs, but overall, the factors should be positive, and there's certainly the risk that equities just continue to grow over the course of the next year. Read the original article on Investopedia.
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