A close look at this week’s trending topic

US consumer price inflation data slightly exceeded market expectations in September. Markets pared their expectations for future Fed rate cuts. But a single data point doesn't derail the case of easier monetary policy in the US and elsewhere. Now's time to position for lower rates, diversify sources of income, and use possible volatility to buy stocks at potentially more appealing prices.

Higher-than-expected US inflation data released on 10 October added fuel to some investors’ concerns that the US economy’s strength may stay the Federal Reserve’s hand in cutting interest rates.

The core consumer price index for September, which excludes volatile food and energy prices, rose 0.3% for the second consecutive month, slightly above consensus estimates of 0.2%, and bringing year-over-year core inflation to 3.3%, up from 3.2% in August.

This followed a stronger-than-expected September employment report in which unemployment fell one-tenth to 4.1%, the US generated a net 254,000 jobs over the month (above the consensus forecast of 150,000 and the strongest monthly increase since January), and the annual rate of average hourly earnings grew 4%, from 3.8% in August. In combination, these signs of robust US economic activity led to a scaling back in the likelihood of another Fed 50-basis-point cut and an increase in the chances the Fed leaves rates unchanged in November—with markets now implying a roughly 10% chance that no cut will occur at the upcoming policy meeting, up from 0% last week.

But investors should not interpret a single US inflation print as reason for the global rate-cutting cycle to end:

Price pressures continue to subside, despite monthly fluctuations. While US consumer price inflation was slightly higher than expected, there were also some positive developments. Headline inflation eased to 2.4%, marking the lowest rate since 2021. The most recent reading of the personal consumption expenditure index (PCE), the Fed's preferred measure of inflation, came in below expectations and showed annual inflation slowing to the lowest level since February 2021. It is possible this divergence between the two main inflation measures could occur again in September. And last week's flat reading for producer price inflation, with declines in goods prices balancing out modest service cost increases, looks consistent with US inflation falling back into ranges consistent with the Fed’s 2% target.

The minutes of the Fed's last meeting underline a desire by top officials to move rates down from current restrictive levels. In discussing the outlook for monetary policy last month, Fed officials anticipated a “move toward a more neutral stance of policy over time” if economic data continue to come in about as expected, according to the minutes released Wednesday. While policymakers may not see the urgency to move as quickly as they did in September, as some “would have preferred a 25-basis-point reduction,” they acknowledged the restrictiveness of monetary policy.

The case for other major central banks to cut rates is even more clearcut. Eurozone activity and inflation data may prompt the European Central Bank (ECB) to cut rates again this week. September headline inflation of the bloc printed 1.8% year over year, below the 2.2% rate in August and putting the central bank’s 2.3% forecast of third-quarter inflation at risk of looking over-optimistic. Combined with weak activity, we think the ECB will cut rates every meeting from this month until next June, for 150bps of total rate reductions. The Swiss National Bank (SNB) recently cut interest rates by 25bps to 1% but indicated there may be additional easing to prevent inflation from slowing further. We now expect two further rate cuts from the SNB to 0.5% by March 2025.

So, we believe investors should keep positioning for lower rates. Further global rate cuts will likely erode returns on cash, money-market holdings, and expiring fixed-term deposits. A combination of bond ladders, mediumduration investment grade bonds, diversified fixed income strategies, and equity income strategies can all play a role in sustaining portfolio income as interest rates decline. We favor 1-10 year bonds and an average 5-year portfolio duration.

In equities, we believe US third-quarter earnings season will conclude with S&P 500 earnings per share (EPS) growth of 5-7%, lower than the 11% posted in the second quarter as a result of lower oil and gasoline prices, but consistent with our 2024 full-year earnings growth forecast of 11%. With large-cap corporate profit growth likely to remain solid against a constructive macro backdrop, we reiterate our S&P 500 price target of 6,200 by June 2025.

We continue to see opportunities in the AI value chain. Investors looking to add AI positions can turn volatility into an opportunity to build positions at lower prices, using structured strategies. Within tech, we prefer AI-linked semiconductors, US megacaps, and select Chinese internet leaders. Capital preservation strategies may shield existing positions from market swings. Broadening earnings growth may also support select areas of the US market beyond technology like financials and utilities.

With the Fed having more room to cut rates than other central banks to move policy back toward neutral, we think the US dollar should weaken further. Investors should reduce USD exposure, including hedging assets, diversifying internationally, or using options. We expect a stronger Swiss franc (CHF), as the Swiss National Bank is likely closer to the end of its rate-cutting cycle than peers. Investors that borrowed in francs can consider hedging against CHF appreciation. Gold should rise on firmer central bank and investor demand, lower rates, and USD weakening, in our view.