Explaining the Fed's cut, and the yield spike that led into it

The 25 basis point cut to interest rates by the US Federal Reserve yesterday was by no means a surprise. It had been largely anticipated by investors and analysts alike, with some small upticks in inflation and downturns in employment following the Fed’s “jumbo” 0.50 per cent rate cut in September. It is notable, though, that yields on US government bonds had steadily ticked up over the past few months, with a spike immediately following the news of the US election results on Wednesday morning.

Michael Currie, Senior Investment Advisor with TD Wealth Private Investment Advice, explained some of why we saw that uptick in yield despite the ongoing rate cutting cycle. He highlighted the areas of opportunity for investors now and drove home how advisors can message to clients about this news and the wider US macro story.

“Nothing dramatic has changes, the biggest takeaway [from the Fed announcement] would be that there’s a lot of focus on employment,” Currie says. “For the last year all we’ve been hearing about is inflation, and rightly so…But they seen a little more focused on employment now.”

Currie notes that when employment features more heavily in Fed communications, it implies greater likelihood of future cuts. This cut does follow a very disappointing topline October jobs report, which may have been skewed by the impact of major hurricanes. Given the slowdowns we’ve seen in the US economy, Currie believes we should expect maybe one more 0.25 per cent cut in December. He has less clarity about cuts going into 2025.

Despite the poor October jobs numbers, Currie emphasizes the relative strength of the US economy compared to Canada and other developed countries. That relative strength, he says, feeds into the relatively shallow cuts we’ve seen from the Fed so far.

There are mixed signals in the US economy, though. While employment was weak in October, CPI came in unexpectedly high, giving some investors pause and pushing yields slightly higher. The US election results also sparked an uptick in yield. Many investors expect that President Elect Trump’s stated policies of deportation, tariffs, and high government spending will be inherently inflationary. Currie explains that this consensus pushed yields higher in the leadup to the Fed announcement.

Following the announcement yields fell and bond investors got a bit of relief. Nevertheless the increase during a cutting cycle poses some challenges for investors and advisors. Currie notes that speculation plays a role in that short-term market volatility. Just as the Fed’s past hikes are still impacting the US economy, even if Trump takes office and immediately implements tariffs, the inflationary side should take a while to kick in.

Because he attributes some of the bond volatility to more short-term speculation, Currie sees opportunities in the bond market long-term. Given the fall in yields accessible to Canadian investors through vehicles like GICs, Currie sees a need for alternate yield vehicles. He believes that there may be opportunity in the bond market on the longer end of the yield curve. Adding duration in a bond portfolio now may be a strong way for investors to access that yield. Given the spikes we’ve seen in yields, though, there may be some short-term volatility that bond investors will have to endure.

Looking at equities, despite the broadly expensive stock market that has emerged due to this bull run, Currie sees value in more conservative dividend stocks that had struggled more during the rate hiking cycle. Despite the more expensive market overall, he believes that there are pockets of the stock market where savvy advisors can still find value for their clients.

With a Fed meeting coming right after a presidential election, clients may be forgiven for feeling a bit of news fatigue, or even whiplash. Currie believes that advisors can simply remind clients of the fact that we are in a bull market. That doesn’t mean there won’t be blips experienced, even on relatively stable ends of the portfolio like bonds, but Currie argues that advisors can serve their clients well by reminding them of the big picture rather than engaging in speculation.

“It's still a bull market in the States and Canada too. It's still a decent economy in the States. So I'd say there's nothing to me that really happened in the election, aside from some short term more speculative trades, that would really knock things off kilter,” Currie says. “Interest rates are big, you don’t want to underestimate them. No advisor out there should be talking to someone without talking about interest rates. But it’s important to remember we’re in a strong bull market.”