Searching for opportunities in the global rate-cutting cycle

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The long-awaited global interest rate-cutting cycle is well underway. Following the Federal Reserve’s 50 basis point (bp) rate cut in September, most major developed market central banks have now started to lower borrowing costs.

Change in policy rates by central banks overseeing the 10 most traded currencies.

Source: LSEG | REUTERS

This is potentially a pivotal moment for investors. After an aggressive series of interest rate hikes, the shift to a rate-cutting environment could lead to new investment opportunities in both the bond and equity markets.

Easing inflationary pressures

The primary driver of the move to lower interest rates is the easing of inflationary pressures across developed economies. The inflation shock of 2022 that saw price rises reach levels not seen in decades appears to have finally passed into the rear-view mirror.

Having risen to 10.6% in October 2022, the annual inflation rate in the euro zone fell to 2.2% in August, edging close to the European Central Bank’s (ECB) 2% target. A similar picture can be seen in the US where the Consumer Price Index (CPI) rose 2.5%, year on year, in August; in the UK, CPI rose by 2.2% in July.

Moreover, the global economy appears to be returning to a more normal state after the extraordinary disruption caused by the COVID pandemic.

Having hiked rates aggressively to bring inflation under control and reduced some of the liquidity in the financial system, central banks appear to be confident that inflation is on a sustainable path towards their targets and they can begin loosening monetary policy.

While some inflation measures such as services remain sticky and there some concerns about a possible resurgence of inflation – for instance, former US president Trump’s proposed tariffs on imports could lead to prices rising – policymakers can arguably move on from inflation and focus their attention on factors such as sustaining economic growth and employment.

With equity markets such as the S&P 500 Index in the US trading at levels close to record highs, there appears to be a high degree of confidence that policymakers have been successful in bringing down inflation without causing an economic downturn, the so-called soft-landing scenario. (A soft-landing is a cyclical slowdown in economic growth that ends without a period of outright recession).

This is not unprecedented but, in the past, many rate-cutting cycles have started because the economy has weakened. At present, it appears that the economy has been able to adapt to a world of higher interest rates. However, the longer that rates stay elevated, the higher the possibility of a recession, in our view.

Looking ahead to 2025, there is uncertainty about the destination in this cutting cycle. However, given the historically low, zero-interest rates that were implemented in the years after the financial crisis of 2008/2009, it is likely that rates will settle at a level higher than they were before the hiking cycle began.

A favourable environment for bonds?

From an investment perspective, we believe there are a number of areas that might benefit from this loosening of monetary policy. Fixed income assets are generally considered to perform well in a rate-cutting environment. When interest rates fall, this can make the fixed amount of income provided by bonds more attractive to investors.

Government bonds, in particular US Treasuries, have performed well in recent months as investors have anticipated the start of the rate-cutting cycle. However, we believe they remain an attractive investment option, with some government debt instruments offering yields that arguably look attractive in real, or inflation-adjusted terms.

Significantly, we believe government bonds currently have an attractive risk-reward profile. There is an asymmetry at play: in our view, it seems unlikely that interest rates are going to go up in the near term – a scenario which would hurt bonds.

In contrast, should economic growth disappoint or economic conditions worsen, policymakers may cuts rates aggressively, a move that could be favourable for government bonds, especially those with longer duration, which are more sensitive to changes in interest rates.

Long-term government bonds, therefore, could provide investors with some valuable portfolio diversification in the event of an economic slowdown.

Tailwind for Listed Infrastructure?

Another asset class that could potentially prosper as rates come down is Listed Infrastructure. The asset class, which includes the shares of utilities and real estate companies, came under severe pressure when borrowing costs were rising because these types of business were perceived to be sensitive to changes in interest rates.

Now that rates are being lowered, we believe Listed Infrastructure could benefit from a more favourable tailwind. Historically, the asset class has performed extremely well once the Fed has stopped hiking rates.

Many of the companies in this category operate critical physical infrastructure – transport, power plants and data centres, for example – that represent the backbone of the global economy. As a result of their essential nature and long-lasting operation, these assets typically generate stable, long-term cashflows, whatever the economic conditions. These cashflows are often linked to inflation and grow over time, enabling companies to provide their shareholders with growing distributions that provide a degree of protection against inflation.

While most infrastructure businesses such as airport operators and payments companies benefit from buoyant economic activity, the asset class could also perform well in uncertain times, in our view, due to the stability of the services it provides. We believe the prospect of an attractive and reliable level of income makes Listed Infrastructure an appealing investment option at this time, especially if interest rates fall rapidly as central banks respond to economic weakness.

Navigating the monetary cycle

The direction of travel for interest rates may now be clear but the destination remains uncertain. Central banks will be carefully calibrating their policy to balance the dynamics of inflation and economic growth. Navigating the next phase of the monetary cycle will likely be challenging but government bonds and listed infrastructure could be two strategies that prove rewarding in the new environment.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. The views expressed in this article should not be taken as a recommendation, advice or forecast.