US Fed opts for rate cut, with December still in play, while European Central Bank finds itself in “good place”

US Federal Reserve

At its meeting on Wednesday 29 October, the US Federal Reserve (Fed) cut interest rates by 0.25% bringing the Federal Funds target range to 3.75%-4.0%, much as the market had been expecting. With one member calling for no cut, and another for an immediate reduction of 0.50%, there was clearly a significant divergence of views amongst the Committee members. On the more hawkish side, “inflation has moved up since earlier in the year and remains somewhat elevated”, whilst on the dovish side, “the Committee is attentive to the risks to both sides of its dual mandate and judges that downside risks to employment rose in recent months”. The Fed is certainly having a tricky time, particularly given the political pressures emanating from the Donald Trump administration.

But it was Chair Jerome Powell’s cautious signal that a December rate cut was “far from” a foregone conclusion that caught the financial market’s attention. Particularly so given a further reduction to the Federal Funds target range of 0.25% was fully priced for December 2025, ahead of the meeting. The Committee also decided to end quantitative tightening (QT).

Yet the market is still pricing a 70% probability of 0.25% interest rate cut in December, and three further 0.25% interest rate reductions thereafter in 2026.

Financial markets reacted by pushing yields higher, led by the front end of the curve. Given Powell’s comments, the magnitude of the move in the immediate aftermath feels about right. However, it is the longer-term pricing of the neutral rate that feels stretched. Powell indicated that the current Federal Funds rate is in the range of neutral for some members. Yet the market is still pricing a 70% probability of 0.25% interest rate cut in December, and three further 0.25% interest rate reductions thereafter in 2026. Markets have long moved on from simply pricing interest rates in relation to economics.

Views on politics and the Trump administration’s influence on the Fed will continue to rumble well into 2026, and that makes calling the future path of interest rates more challenging. Our view, based largely on economic fundamentals, is that the neutral Fed Funds rate is a little higher than the market is pricing; as a result, we remain underweight US treasuries, particularly in shorter maturities.

European Central Bank

The European Central Bank (ECB) maintained its deposit rate at 2.0%, at its meeting on Thursday, 30 October. President Christine Lagarde maintained that the ECB’s Monetary Policy settings remain in a “good place”, and that the Governing Council will continue to take a “data-dependent”, “meeting-by-meeting” approach when considering the appropriateness of monetary policy.

Yields on shorter maturity German bunds have been in a well-defined trading range for much of the last few months. The immediate bond market response has been muted, with yields largely unchanged.

With regards to inflation, little has changed since the last meeting; inflation is at or close to the 2.0% target, and the medium-term outlook remains broadly balanced. However, Lagarde did note that some of the downside risks to growth had abated, highlighting the US-EU trade deal, the ceasefire in the Middle East, and progress around a US-China trade deal.

Yields on shorter maturity German bunds have been in a well-defined trading range for much of the last few months. The immediate bond market response has been muted, with yields largely unchanged. Given the current outlook for both inflation and growth, and with the ECB policy rate being judged as lying close to neutral, this is likely to persist, with underlying volatility being driven more by global headlines, domestic politics, and fiscal policy, than monetary policy.

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