The Fed's Rate-Cutting Path and Its Implications for Risk Assets

The Federal Reserve’s 2025 rate-cutting path is shaping up to be a pivotal force for global investors. With the September 2025 meeting poised to deliver the first of three 25-basis-point reductions, the central bank’s pivot from tightening to easing is creating a new paradigm for risk assets. According to a report by J.P. Morgan Research, the federal funds rate is projected to fall to 3.25–3.5% by early 2026, a decline of 100 basis points from its current range of 4.25–4.5% [4]. This shift, driven by moderating inflation, cooling labor market data, and the drag of tariffs on imported goods, is already prompting institutional investors to recalibrate portfolios [1].

The Fed’s Dovish Turn: A Product of Economic Realities

The FOMC’s July 2025 statement underscored a delicate balancing act: while inflation remains above the 2% target (core PCE at 3.0%), growth has softened to 1.4% in 2025, and the unemployment rate is projected to stabilize at 4.5% [1]. These dynamics have eroded the urgency to maintain restrictive rates. As stated by the Federal Reserve, “uncertainty about the economic outlook remains elevated, and the Committee remains attentive to risks to both sides of its dual mandate” [1]. The September 17 meeting is now widely seen as a critical inflection point, with the CME Group’s FedWatch tool pricing in a 90% probability of a cut [2].

Strategic Asset Allocation in a Rate-Cutting Environment

The implications for risk assets are profound. Historically, rate cuts have amplified returns for long-duration assets while squeezing short-term fixed income. For equities, large-cap growth stocks—particularly in technology and renewable energy—are expected to outperform. Lower discount rates will boost valuations for companies with extended cash flow horizons, while sectors like AI and semiconductors benefit from reduced borrowing costs for R&D [3]. Morgan Stanley’s Global Investment Committee has advised overweighting U.S. large-cap quality names and consumer-oriented sectors, citing their resilience in a dovish policy environment [1].

Bonds, meanwhile, are entering a sweet spot. High-yield bonds, with a yield to worst of 7.3%, offer compelling risk-adjusted returns, especially if the Fed’s easing avoids triggering a recession [3]. A balanced approach to duration—extending maturities selectively while retaining short-to-intermediate holdings—can mitigate reinvestment risk while capturing yield [5]. For inflation hedging, TIPS and commodities remain essential, given the lingering risks from tariffs and global supply chain disruptions [5].

Real estate markets, however, face a more nuanced picture. While lower mortgage rates could stimulate housing demand, affordability challenges persist. The average 30-year mortgage rate remains at 6.8%, well above pre-2020 levels, constraining home sales [4]. Institutional investors are pivoting to real assets like data centers and logistics infrastructure, which remain insulated from trade policy volatility [1]. REITs, though underperforming the S&P 500, offer defensive appeal in a low-rate world, particularly for those with exposure to industrial and healthcare sectors [4].

Navigating Uncertainty: A Call for Flexibility

The Fed’s path forward is far from certain. While J.P. Morgan projects 100 basis points of cuts in 2025, the FOMC’s June 2025 projections suggest a more cautious 50-basis-point reduction, reflecting the committee’s wariness of inflation stickiness [2]. This uncertainty underscores the need for flexible, data-dependent strategies. As highlighted in J.P. Morgan’s mid-year outlook, investors should prioritize sectors with strong secular growth (e.g., AI, clean energy) and maintain liquidity to capitalize on potential dislocations [2].

Global central bank easing and U.S. fiscal stimulus in 2026 could further amplify risk-on sentiment, but trade policy developments remain a wildcard. Morgan Stanley recommends diversifying into real assets like gold and energy infrastructure to hedge against geopolitical risks [1]. Active stock selection and tactical shifts in bond duration will also be critical as the Fed’s policy trajectory evolves.

Conclusion

The Fed’s 2025 rate cuts are not merely a technical adjustment but a catalyst for rethinking asset allocation. Investors who position for a dovish cycle—leaning into long-duration equities, high-yield bonds, and resilient real assets—stand to benefit from the Fed’s pivot. Yet, the narrow path to a “soft landing” demands vigilance. As the September meeting approaches, the interplay between inflation, employment, and trade policy will remain the ultimate arbiters of risk asset performance.

Source:
[1] Global Investment Committee, Morgan Stanley [https://www.morganstanley.com/insights/articles/fed-rate-cut-september-2025-forecast]
[2] FOMC Projections, Federal Reserve [https://www.federalreserve.gov/monetarypolicy/fomcprojtabl20250618.htm]
[3] The Case for a Fed Rate Cut and Its Implications for Risk Assets [https://www.bitget.com/news/detail/12560604940134]
[4] Impact of Changing Interest Rates on the Housing Market [https://www.usbank.com/investing/financial-perspectives/investing-insights/interest-rates-impact-on-housing-market.html]
[5] Mid-Year Market Outlook 2025, J.P. Morgan Research [https://www.jpmorgan.com/insights/global-research/outlook/mid-year-outlook]