Short-term markets during rate cuts

Inflation and labor market conditions align with the Federal Reserve's criteria for a potential rate cut, leading to speculation about the timing and scale of easings in 2024. Markets expect cuts at all remaining Federal Open Market Committee (FOMC) meetings this year, with the Short Term Investments Committee forecasting a quarter-point cut in September, subject to adjustments from August data.

Anticipation of rate changes has already driven down Treasury yields, notably the 2-year yield, which declined from over 5% to near 4%. This decline suggests expectations of approximately 300 basis points of cuts over two years, stimulating interest in short-duration investments, especially as longer-duration securities typically experience greater price increases.

Attractive relative value is noted in AAA-rated asset-backed securities and Agency mortgage-backed securities. When the FOMC cuts rates, a shift is expected in Secured Overnight Financing Rate (SOFR) and floating-rate notes, leading to lower distribution and liquidity yields.

This could prompt investors to switch from direct securities and bank deposits to higher-yielding money market investments and pursue short-duration assets for better returns. Ultimately, proactive investment adjustments ahead of official policy changes could be beneficial as markets often react before the Fed's decisions are made.