The next catalyst: Rate cuts vs. political risks

It’s a tug of war between politics, policy, and a cooling economy.

Last week’s narrative flipped fast

The week began with a global bond sell-off—US, UK, and French yields surged to multi-year highs as investors fretted over fiscal strains, US tariffs, and Fed independence. But, confidence in Fed rate cuts quickly took over: US stocks, led by technology, soared to new highs, and bonds rebounded as jobs data pointed to a cooling labour market.

Friday’s US jobs report disappointed: payrolls rose by just 22,000 in August, well below the 75,000 expected. Revisions showed June had the first monthly job loss since 2020. Unemployment ticked up to 4.3%, and for the first time in four years, jobseekers outnumbered openings. Traders are now betting on a Fed rate cut next week—some even eyeing a larger 50bps move, though 25bps looks more likely. With the Fed now in a media blackout, attention turns to Wednesday’s PPI and especially Thursday’s CPI for the next clues.

The week is made even busier with political drama. In France, Prime Minister Bayrou faces a confidence vote today that could force President Macron to appoint a new leader—potentially the fifth in just two years. The gap between French and German bond yields—a key risk gauge—is at its widest in years, signalling markets have priced in a fair amount of the uncertainty. In Japan, Prime Minister Ishiba resigned over the weekend after poor summer election results, but markets remain steady as fresh data showed the strongest five-quarter growth streak since 2016–18.

Bottom line: Politics are in flux, but the Fed’s next move still appears to be the clearest catalyst for investors. Rate cuts could reset the playbook for generating income and managing risk. Below, we break down what this means for investors—and where we see value.

What happens when the Fed cuts?

Rate cuts tend to ripple through markets before the Fed even makes its first move. Cash rates, such as your money market yield, are usually the last to react.

We are seeing this play out now. The overnight lending rate between banks (SOFR) is still around 4.4%, but the three-month Treasury bill—a proxy for cash-like investments—has already dropped to 4.1%. That suggests investors expect the Fed to cut rates in September, with further cuts likely after that. The same trend is evident at other maturities: the twelve-month Treasury bill is down to about 3.6%, and the two-year Treasury yield has fallen by nearly half a per cent since June.

Why it matters: The “yield curve”—which shows how much more you can earn by locking in your money for longer periods—is now much steeper. Longer-term bonds are paying significantly more than cash. Two years ago, short-term rates were just as good as longer-term bonds, offering little incentive to move out of cash. Now, the gap is much wider.

Large companies are taking notice. Firms such as Uber, Netflix, Coca-Cola, PepsiCo, Philip Morris, and Honeywell are borrowing for just a few months at a time, expecting to refinance at lower rates soon. For everyday investors, this is a cue: while companies remain flexible with short-term borrowing, you might wish to do the opposite— lock in today’s higher yields with longer-term bonds before rates fall further.

Are bonds “too expensive”?

Credit spreads are tight—meaning, it seems like investors are not receiving much extra yield for taking on corporate bond risk, making corporates appear expensive compared to government bonds.

But there is more to it:

• Benchmarks matter: Most compare corporates to Treasuries, but Treasury yields today are inflated by deficits and supply. That makes the “extra yield” on corporates appear smaller. Comparing to SOFR swaps—the overnight bank lending rate—and spreads look much more normal.
• Corporate fundamentals are solid: Companies have strong profit margins, manageable debt, and are not overdoing mergers. Credit quality is holding up.
• Market dynamics help: There is not a flood of new corporate bonds, and steady investor demand supports high-quality income.

The signal: Tight spreads appear justified in this environment.

History shows that after the Fed’s first rate cut, policy rates usually drift lower—by about a percentage point over the next year, outside recessions. We have focused on intermediate-term bonds (“the belly of the curve”) to earn income and avoid long-term volatility, and so far, that has worked. With rate cuts ahead, short-term Treasuries already yield less than today’s 4% cash, so reinvestment risk is real.

What it means for you

Be cautious about remaining in cash. The upside: when the Fed cuts rates—especially outside recessions—risk assets usually benefit. Equities tend to rise, fixed income investors are rewarded for locking in yields, and the dollar often weakens.

Within fixed income, we are focused on investment-grade bonds under ten years. These high-quality corporates offer steady, mid-5% yields with less volatility than longer bonds. For context, $1 million at 5% yields about $50,000 a year before tax. The market is deep, income is reliable, and rate risk is more limited.

We also favour subordinated and hybrid bonds from banks, utilities, and telecoms. These sit between bonds and stocks, typically pay more than regular bonds, and are issued by financially strong companies.

Bottom line: The Fed’s next move reinforces our view to remain fully invested, and diversify across asset classes and regions. Your JPMorgan team can explore these dynamics and what it means for your portfolio.