The Potential Benefits of a Fed Shift from Hawkish to Dovish

As has been noted in the press recently, the likelihood of a FOMC rate cut at the September meeting (9/16-9/17) have gained traction according to the CME FedWatch Tool which currently show a probability of a 25 basis point (bp) rate cut at ~87%.  This shift in the Federal Reserve’s policy stance, from hawkish to dovish, may meaningfully reshape the economic and market landscape. When the Fed signals a move away from fighting inflation toward supporting economic growth, it tends to trigger a multi-asset transition that can create compelling opportunities for investors across equities, bonds, and real assets. While this is generally the case, we do realize that there are still concerns around inflation and the potential impacts of further Trump Tariff actions. For now, however, we would like to focus on the potential positive impacts that a shift in the FOMC to a dovish stance may have if/when a rate cut cycle is initiated.

1. Equity Markets Potentially Gain Traction in Supportive Conditions

Historical evidence shows that equity markets tend to benefit from a Fed easing cycle, especially when economic growth remains positive.

• In expansionary rate-cut cycles, equities, particularly small-cap and growth sectors, have often been strong performers. When rate cuts are paired with a favorable growth backdrop, markets tend to sustain upward momentum. Without going into the weeds, when the 10-year US Treasury moves lower, this typically creates a situation where the discount factor used in equity valuations is lower resulting in higher present values of projected future cash flows (i.e., higher current valuations).
• Since 1985, five of the S&P 500’s best 10 calendar years occurred during rate-cut cycles not associated with recessions, highlighting the positive correlation between easing and equity performance.
• Moreover, studies indicate that equity markets typically rally during the first 90 days after the start of a cutting cycle -> reinforcing the “don’t fight the Fed” mantra. This is a great time to note that past performance is not indicative of future results. We are simply pointing out empirical evidence.

2. Bond Investors Stand to Benefit from Lower Rates

• U.S. government bonds have historically delivered positive returns in nearly all rate-cutting cycles, regardless of whether growth slowed or continued.
• Lower short-term interest rates often reduce funding costs and improve fixed-income returns, while longer-duration bonds can rally as inflation expectations moderate. This is one of the keys reasons that we began expanding our overall duration ahead of the previous rate cuts, and this is still the belief of our Investment Committee at this time. By extending duration further out the curve, you are better situated to potentially benefit from possible price appreciation and more attractive rates.

3. Consumer Spending and Inflation Dynamics Improve

Interest rate cuts can help stimulate consumer confidence and spending unless they’re signaling an impending recession.

• During past rate-cut cycles, consumer spending has risen meaningfully, even as inflation eased further.
• This combination of an accommodative monetary policy with stabilizing prices creates a favorable environment for household budgets and corporate revenues. This is one area where we will need to continually monitor the potential inflationary impact of the Trump Tariffs. If the cost of goods increases to a level where more dollars are going to inelastic goods (e.g., groceries, utilities, healthcare, etc.), then there could potentially be a shift lower in goods/services that are considered elastic/discretionary spending. Again, this is an issue that we will continue to monitor as more information becomes available.

4. Mortgage Rates and Housing Activity

One of the most immediate impacts of a dovish shift is seen in mortgage rates. As the Fed reduces the federal funds rate, yields across the Treasury curve typically fall, pulling down average 15- and 30-year mortgage rates.

• Housing affordability improves (potentially): Lower mortgage costs allow more buyers to qualify for loans, stimulating demand in the housing market.
• Wealth effect for homeowners: Refinancing opportunities can reduce monthly payments, freeing cash for discretionary spending.
• Construction & related sectors: A pickup in housing activity often cascades into construction, durable goods, and local service economies—multiplying the economic benefit. This is also an area where we are continuing to monitor given some of the labor shortages in the construction and related sectors.

This potentially makes a dovish pivot particularly impactful for households who have been sidelined by high borrowing costs over the last two years. Given the rates that many locked in ahead of the 2022 rate hiking cycle, there has been a conundrum for individuals that would like to potentially upgrade to a different house because they are concerned about leaving the attractive mortgage rate that they may already have locked in for an extended period.  If mortgage rates come down to a more manageable level, this could create a scenario where more individuals will be willing to make the move (pun intended).

5. Labor Market Implications — Supporting the Fed’s Mandate

The Federal Reserve operates under a dual mandate: price stability and maximum employment. While hawkish policies help suppress inflation, they also risk slowing job creation as borrowing costs rise and businesses curb investment. This is something that we may be seeing play out in real time post the last Non-Farm Payrolls data for July.

• Rate cuts lower hiring costs: As financing expenses ease, companies are better positioned to expand payrolls, invest in training, and re-accelerate hiring.
• Stimulating sluggish participation: Lower borrowing costs can help industries like housing, manufacturing, and small business, sectors that are labor-intensive and sensitive to credit conditions, restart job growth.
• Balancing act: A more dovish Fed can support job creation while inflation expectations continue to moderate, directly addressing both sides of its mandate. This is the fine line that the FOMC must walk in the current environment.

6. Potential Implications Across Assets

A dovish Fed and lowering interest rate regime present several strategic opportunities:

• Equities: Growth-oriented sectors and small-caps often outperform when financing conditions ease (remember the valuation commentary above).
• Fixed Income: Longer-duration Treasuries and high-quality corporates benefit from falling yields.
• Income & Tax Planning: With lower yields and potential return-of-capital structures in play, investors can rebalance to harvest income while cushioning volatility. This is an area where it is important to have a conversation with your advisor and/or tax professional.

In closing, a shift in Fed policy from hawkish to dovish, especially when rates are cut during a still-growing economy, acts as a strong tailwind for equities, bonds, housing, and the labor market. Lower borrowing costs stimulate housing demand, ease mortgage burdens, and free up consumer spending. At the same time, easier credit conditions support business hiring, helping the Fed advance its employment mandate while maintaining downward pressure on inflation. For investors, such a backdrop historically delivers higher yields, smoother equity returns, and renewed opportunities to position portfolios for growth. While we still face certain challenges (i.e., tariffs and labor demand issues), we do believe that the underlying economy is still performing well and will potentially benefit from a rate cutting cycle.

If you have any questions or concerns about how a more dovish FOMC may impact your overall portfolio, please reach out to your advisor and schedule a meeting to discuss. As we have stated in the past, your Financial Peace of Mind is our top priority, and will be here to navigate any potential shifts in the economy. We hope that you have a great end of the summer!