TL;DR
- Vanguard warns markets are pricing in too many Fed rate cuts.
- Strong AI investment boosts growth but complicates inflation control.
- Fed official warns leveraged hedge funds risk Treasury market stability.
Vanguard warns that traders expect far more Federal Reserve rate cuts than are realistic. Sara Devereux, the firm’s fixed-income chief managing $2.8 trillion, says only one or two cuts remain likely after the two quarter-point reductions already executed this fall.
Markets continue pricing in three to four cuts before 2026 ends, creating a gap between expectations and reality. “Too many Fed cuts are priced into the market right now,” Devereux told the Financial Times. “The market is over-relying on that.” She projects rates may reach a neutral point by mid-2026, where monetary policy neither accelerates growth nor slows it, limiting room for additional easing.
The Fed remains split on next steps, weighing labor market softness, sticky inflation, and stable growth. Hopes of a December cut have cooled, nudging stocks lower as investor optimism fades.
AI spending fuels growth and constrains policy easing
Vanguard forecasts U.S. GDP at 1.9% for 2025, rising to 2.25% in 2026 due to surging artificial intelligence investment. Devereux highlights a massive increase in tech capex, including chips, data centers, and cloud infrastructure, which strengthens growth and complicates the Fed’s task of easing rates without reigniting inflation.
Her team revised growth forecasts sharply following recent earnings, noting AI spending as the primary driver. “We took our GDP forecast up a lot and it was really mostly based on that,” she said.
Corporate bonds face downward pressure as firms such as Amazon, Meta, Alphabet, and Oracle issue large volumes. JPMorgan estimates 2026 corporate bond issuance could reach $1.8 trillion, forcing markets to adjust.
Treasury market risks from hedge fund trades
Lisa Cook, a Fed board governor, cautions that hedge fund basis trades amplify risk. These trades exploit small price differences in Treasury securities, improving efficiency under normal conditions but potentially triggering instability during market stress.
Data shows Cayman Islands-based hedge funds absorbed more Treasury issuance from 2022–2024 than all other foreign private holders combined, with holdings rising to 10.3% of Treasury cash securities, surpassing the pre-COVID peak of 9.4%.
Cook warns that history may repeat: the 2019 repo meltdown and the March 2020 COVID panic both stemmed from similar leveraged strategies. She notes that risk is resurfacing and growing, making the Treasury market more vulnerable to sudden stress events.
Vanguard’s outlook underscores a disconnect between market expectations and Fed policy reality, highlighting how AI-driven growth and complex Treasury trading strategies reshape risk for investors and policymakers alike.
