FOMC: The Fed reacts to economic uncertainty amidst the government shutdown

Highlights: The Federal Reserve cut interest rates by 25bps to the target range of 3.75 per cent–4.00 per cent, its second reduction of the year, while signalling a more balanced stance toward inflation and employment. The FOMC also confirmed plans to end Quantitative Tightening (QT) on 1 December, marking a key shift in liquidity management as it transitions toward a neutral policy stance. Early market reaction was cautious – as US equities were mixed, Treasury yields rose modestly, and the dollar strengthened as traders scaled back expectations for additional near-term cuts. We maintain our neutral view on the dollar and reiterate our call of adding to quality bonds, with preference for global IG. We remain mildly overweight on US equities as we believe robust mega-cap earnings and the AI theme should provide tailwinds for the rally to extend.

• The end of QT underscores the Fed’s intention to balance two-sided risks, maintaining flexibility while ensuring liquidity remains ample as balance sheet runoff concludes
• Fed Chair Powell emphasised that central bank policy is not on a preset course, describing another rate cut in December as “far from a foregone conclusion.” He noted that economic growth has moderated, with GDP expanding 1.6 per cent in the first half of 2025, down from 2.4 per cent last year, supported by resilient consumer spending and business investment but offset by continued housing weakness
• Powell mentioned that inflation has eased significantly from its highs in mid-2022. In his opening statement, he said that estimates based on the Consumer Price Index suggest that total PCE prices rose 2.8 per cent y-o-y in September, and that, excluding the volatile food and energy categories, core PCE prices rose 2.8 per cent y-o-y in September as well
• We still expect a 25bp rate cut at the next FOMC meeting on 9-10 December but no additional reductions next year, bringing the target range down to 3.50-3.75 per cent by end-2025 and keeping policy rates on hold through 2026 and 2027
• For US equities, lower policy rates should be accretive to earnings and help keep valuations in check. For fixed income investors, the Fed cut after a pause provides positive returns in the 12 months following the first ease. Typically, the yield curve follows the policy rates lower but there may continue to be friction in the Treasury markets due to the government shutdown, federal fiscal issues, and long-term deficit reduction. History shows the dollar typically weakens when the Fed is easing policy so long as the US economy is not in recession