Flash Insights: Rate cuts and returns—what past Fed cycles reveal

Key takeaways

• As the Federal Reserve (Fed) has shifted its policy stance, we believe now may be an attractive time to step back into the market and put money that has been parked in cash to work.
• Investors can tailor their allocation across various fixed income markets based on individual liquidity and risk profiles to attempt to achieve desired outcomes.
• Short duration¹ debt can offer the ability to generate attractive returns while maintaining a lower risk posture, while core and core plus bond funds may present investors with the ability to lock in durable yields further out the yield curve.

Fed easing has resumed, but there is genuine uncertainty about the path forward as the Fed’s “dot plot” forecast shows the Federal Open Market Committee (FOMC) is deeply divided on where policy should go next. While many investors are anticipating deep interest-rate cuts following the easing moves in September and October, we believe these expectations exceed both the Fed’s communicated outlook and what current economic conditions warrant. Absent a sudden, sharp deterioration in the US labor market, we think the Fed will choose to stay on hold at the December FOMC meeting and then possibly cut once more in the first quarter of 2026.

Against this uncertain background, one thing we can say with high confidence is that we believe the Fed is unlikely to hike rates at this stage. Therefore, keeping money parked in cash-like investments such as money market funds and short-term Treasuries may seem less attractive, and we think it may be time for some investors to consider putting that money to work in fixed income markets.

Historical bond fund performance vs. cash

History suggests that even during periods of heightened market volatility and uncertainty, cash has rarely been the best option for multi-asset investors. We expect cash to underperform other asset classes going forward, and as such it may make sense for investors to look to fixed income for risk mitigation, portfolio diversification and income generation. Analyzing returns over the past 40 years, key Morningstar bond categories have consistently delivered long-term capital appreciation.

We analyzed historical fixed income excess returns versus cash during the previous seven Fed rate-cutting cycles, using return data from Morningstar. We focused on four key bond categories as they are representative of various risk and duration postures investors typically allocate to within their fixed income exposure.

1. Ultrashort bond: for investors who are focused on capital preservation and low volatility. This is first step out of the risk/return spectrum from cash and for investors who have cash needs within a year.
2. Short-term bond: for investors looking for low volatility and liquidity as well as diversification; may be well-suited for those seeking a high-quality portfolio with a time horizon of less than two years.
3. Core bond: for investors that want high-quality, diversified fixed income exposure that can act as a ballast in a portfolio regardless of the market environment.
4. Core plus bond: for investors that want similar features of a core bond allocation, with the ability to generate additional alpha through added investment flexibility and diversification.