From the studio

Video: CIO's Thomas Wacker on whether US fiscal policy is at a breaking point (8:03)

Thought of the day

Concerns over escalating hostilities in the Middle East, uncertainty over US President Donald Trump’s tariffs, and signs of a softening economy make for a challenging backdrop ahead of the Federal Reserve’s policy decision later today. The S&P 500 fell 0.8% on Tuesday, the yield on the 10-year US Treasury fell 6 basis points to 4.39%, and Brent crude oil settled above USD 76/bbl for the first time since February.

The Fed is widely expected to leave its benchmark overnight interest rate unchanged in the 4.25-4.5% range, where it has been since December last year. Investors, instead, will likely focus on the central bank’s updated projections for the economy and the interest rate. In March, when the Summary of Economic Projections was last published, the Fed forecast slower GDP growth and higher inflation in anticipation of Trump’s tariffs.

We continue to expect that the Fed will resume policy easing later this year, and believe investors should put excess liquidity to work as cash’s underperformance comes into focus amid falling rates.

Softening US economic activity should allow the Fed to reduce rates later this year. US retail sales in May fell 0.9% month over month, below consensus estimates and lower than the (downwardly revised) 0.1% decline in April. This marks the largest decrease in four months, suggesting caution in consumer spending. Industrial production in May also fell for the second time in the last three months, while a separate survey showed sentiment among homebuilders slid to the lowest point in 2.5 years. While the US labor market has so far held up reasonably well, we believe the Fed will resume cutting interest rates later this year as the impact of tariffs becomes more apparent and economic activity continues to soften.

Other central banks are still cutting rates. The Swiss National Bank is likely to bring its policy rate 25 basis points lower on Thursday to 0% amid global uncertainty and recent deflation, following the European Central Bank’s cut earlier this month. While comments from ECB President Christine Lagarde hinted at a pause in its easing cycle, we expect another cut in July as any trade agreement with the US remains elusive. While the Bank of England is expected to stay put at its policy meeting this week, a cut is likely warranted in August given soft labor data. UK inflation in May has also moderated. In Asia, we expect regional central banks to cut by 50-75 basis points in the second half of this year amid slower inflation and softer trade data.

Cash has historically underperformed despite its perceived safety. The elevated uncertainty over tariffs and escalating geopolitical conflicts may have increased the temptation for some investors to hide in cash in the near term, but its long-term underperformance compared to other asset classes is a structural phenomenon. The S&P 500 is back in positive territory this year despite the sharp drawdown post-“Liberation Day,” while Treasury yield volatility has stabilized in recent weeks. History also shows that the impact of geopolitical events on equity markets has tended to be short-lived.

So, we think taking on manageable levels of risk with excess cash would improve return potential and combat the corrosive effects of inflation. We recommend phasing into global equities amid near-term volatility, and think high grade and investment grade bonds offer attractive risk-reward and can help hedge against downturns. Investors able to manage the associated risks and complexity of structured strategies can also consider those that can generate yield.