What happened?
The US Federal Reserve (Fed) has lowered its benchmark interest rates by 25 basis points (bps) once again in its latest meeting, which concluded on 18 December 2024.
This was a widely anticipated move, as fed funds futures trading data as of 14 December 2024 had indicated a 96% likelihood of a 25 bps interest rate cut from the current target range of 450-475 bps to 425-450 bps.
More importantly, the Fed’s projections for rates in 2025 indicate fewer cuts than previously forecast, reflecting their concerns about ongoing inflation. Policymakers also increased their inflation estimates for next year.
In fact, the Fed is now projecting two 25 bps interest rate cuts in 2025, down from four 25 bps interest rate cuts based on Fed officials’ forecasts back in September 2024.
The Fed announcement was met with a sharp correction in the US equity markets, with the Dow Jones Industrial Average down 2.58%, the S&P500 down 2.95% and the tech-heavy Nasdaq Composite down 3.56%.
US government bond yields rose, with the two-year Treasury yield increasing by 0.11 percentage points to 4.35%.
Here are our key takeaways from the Fed’s latest meeting, and what would mean for T-bills, fixed deposits, stocks and REITs.
What we learnt from the latest Fed meeting
#1 – The fed cut rates by 25bps
The Fed has lowered its federal funds rate from the current target range of 450-475 bps to 425-450 bps.
This would mark the third time the Fed has cut interest rates since it began the rate cut cycle, with a cumulative 100 bps reduction in the federal funds rate this year: the Fed cut interest rates by 50 bps in September 2024, followed by 25 bps in November 2024 and 25 bps in the latest round of cuts in December 2024.
In making this decision, the Fed noted that recent indicators suggest that economic activity has continued to expand at a “solid pace”, with GDP growth at 2.8% in the third quarter of 2024, about the same as that in the second quarter.
In the labour market, the unemployment rate is higher compared to a year ago, but at 4.2% in November continues to remain relatively low. Overall, labour market indicators are now less tight than back in 2019.
While inflation has eased significantly over the last two years, it remains elevated compared to the Fed’s 2% long run goal. Inflation, based on the Personal Consumption Expenditures (PCE) Price Index rose 2.5% over the 12 months ending November, with core PCE up 2.8%.
To recap, the Federal Reserve’s mandate is to promote maximum employment and stable prices.
#2 – Fed is projecting two rate cuts in 2025, down from four rate cuts back in September
More importantly, Fed officials have projected that the Fed funds rate will fall to 3.75-4.00% by the end of next year.
This would mean that we may see only two rate cuts in 2024, compared to the previous projection for four rate cuts as recently as the Fed’s September 2024 meeting.
Concerns about “sticky” inflation remaining above the 2% target likely contributed to Fed officials projecting just half a percentage point worth of cuts in 2025, with Fed Chair Powell also noted that Fed officials had begun to include assumptions about President-elect Trump’s planned policies in their projections.
#3 – Investors expecting just one rate cut in 2025
While Fed officials are projecting two rate cuts in 2025, investors are forecasting a more modest interest rate trajectory instead, with only one 25bps rate cut most likely.
According to the CME Fedwatch Tool as of 14 December 2024, investors were largely expecting two rate cuts in 2024, bringing the Fed Funds rate to 3.75% to 4.00% by the end of next year.
Clearly, investor expectations on the rate cuts have changed very quickly in the past month alone.
As recent as on 19 November, investors have only ascribed a 22.5% probability of interest rates closing at 4.00% to 4.25% by the end of 2025, with most investors expecting rates to close the year at 3.75% to 4.00% instead.
This would mean that investors are now expecting only one rate cut, instead of two rate cuts previously.
What would Beansprout do?
The key message from the latest Fed meeting is that the pace of reduction in future interest rates is likely to be slower, with inflation concerns likely weighing on policymakers’ minds.
Moreover, with President-elect Trump’s inauguration in January 2025, the outlook for future inflation remains uncertain, given the potential for higher tariffs, immigration controls and lower taxes regulations.
Against this backdrop, we would consider the following:
- Lock in elevated interest rates today
- Look for opportunities in REITs and Banks
#1 – Lock in elevated interest rates today
While the pace of interest rate cuts is still uncertain, rates are still likely to fall in 2025.
We have seen lower interest rates for T-bills and Singapore Savings Bonds over the course of the past year.
For example, the cut-off yield for the latest 6-month Singapore T-bill fell to 3.02%, from an average of 3.75% in June 2024.
Likewise, the 10-year average return of the SSB has fallen to 2.81% in the latest issuance, from 3.33% in June 2024.
The 10-year average return of the SSB is likely to fall further in the next issuance, according to our projections as of 19 December 2024.
You can find out which are the best places to park your cash to earn a higher yield here.
#2 – Look for opportunities in REITs and Banks
With expectations of a slower than expected pace of rate cuts, Singapore REITs have fallen sharply in recent weeks.
As shown in the chart of the iEdge S-REIT index below, the basket of Singapore REITs has returned much of their gains since the 1-year highs achieved in October, given rising bond yields, as investors now expect a slower pace of rate cuts amid inflation concerns. The index is now hovering at price levels prior to the start of the rate cut cycle in September earlier this year.
With expectations of a slower than expected pace of rate cuts, Singapore REITs have fallen sharply in recent weeks.
We remain selective on Singapore REITs, as they continue to face mixed sector fundamentals we highlighted in our earlier report “Renewed Headwinds from Higher Bond Yields”
On the flip side, the prospects of Singapore banks may now be brighter, given lessened Net Income Margin (NIM) pressures typically associated with lower interest rates.
Recently, we shared about DBS as one of the top performing Singapore blue chip stocks in 2024. while offering a dividend yield of close to 5%.
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