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

CONTRIBUTORS

Kristine Hurley

VP, Senior Client Portfolio Manager
Franklin Templeton Fixed Income

Kevin Calabro

VP, Senior Product Specialist
Franklin Templeton Fixed Income

Rick Bihrle

Senior Product Specialist
Franklin Templeton Fixed Income

Matt Colombo

Product Specialist
Franklin Templeton Fixed Income

Sanjana Varma

Product Specialist
Franklin Templeton Fixed Income

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 excess returns to cash.

Growth of US$100
1985–2025

Sources: ICE BofA, Morningstar. Analysis by Franklin Templeton Fixed Income Research. As of October 31, 2025. The ICE BofA US 3-Month Treasury Bill Index tracks the performance of the US Treasury securities maturing in 90 days. Indexes are unmanaged and one cannot directly invest in them. Past performance is not an indicator or guarantee future results.

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.

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.
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.
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.
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.

Securities and Exchange Commission (SEC) Yields as of October 31, 2025

Source: Morningstar. Analysis by Franklin Templeton Fixed Income Research. As of October 31, 2025. Past performance is not an indicator or a guarantee of future results.

Morningstar Bond Categories Excess Returns Versus Cash
1990–2020

Source: Morningstar. Analysis by Franklin Templeton Fixed Income Research. As of October 31, 2025. Past performance is not an indicator or guarantee future results.

Looking at these historical bond returns versus cash, there is a clear trend—bonds tend to outperform cash in a Fed rate-cutting cycle when there is not a broader macroeconomic scenario at play, such as a recession or valuation bubble bursting. The only two rate-cutting cycles in which all bond categories underperformed cash were in 1998 (Long-Term Capital Management crisis) and 2007-2008 (global financial crisis).

Looking at performance during the current rate-cutting cycle (September 18, 2024 – November 7, 2025), the ultrashort bond and short duration bond categories have outperformed cash, while the intermediate core and core plus categories have lagged. This can be attributed to the fact that short-term interest rates remain relatively high; however, continued cuts to interest rates could lead core and core plus bond funds to outperform due to the higher-yielding, longer-duration nature of assets in those categories.

With our expectations for a prolonged, shallow rate-cutting cycle, we believe that these bond categories are four solid options that can fit various client liquidity and risk profiles. We believe that short-duration debt offers the ability to generate attractive returns while maintaining a lower risk posture, while core and core plus bond funds present investors with the ability to lock in durable yields further out the curve.

Endnote

Duration refers to a bond’s sensitivity to interest rates.

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal.

Asset-backed, mortgage-backed or mortgage-related securities are subject to prepayment and extension risks.

Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

Floating-rate loans and debt securities are typically rated below investment grade and are subject to greater risk of default, which could result in loss of principal.

There is no assurance that any estimate, forecast or projection will be realized.

© Morningstar, Inc. 2025. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. All data is subject to change.

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This document is intended to be of general interest only. This document should not be construed as individual investment advice or offer or solicitation to buy, sell or hold any shares of fund. The information provided for any individual security mentioned is not a sufficient basis upon which to make an investment decision. Investments involves risks. Value of investments may go up as well as down and past performance is not an indicator or a guarantee of future performance. The investment returns are calculated on NAV to NAV basis, taking into account of reinvestments and capital gain or loss. The investment returns are denominated in stated currency, which may be a foreign currency other than USD and HKD (“other foreign currency”). US/HK dollar-based investors are therefore exposed to fluctuations in the US/HK dollar / other foreign currency exchange rate. Please refer to the offering documents for further details, including the risk factors.

The data, comments, opinions, estimates and other information contained herein may be subject to change without notice. There is no guarantee that an investment product will meet its objective and any forecasts expressed will be realized. Performance may also be affected by currency fluctuations. Reduced liquidity may have a negative impact on the price of the assets. Currency fluctuations may affect the value of overseas investments. Where an investment product invests in emerging markets, the risks can be greater than in developed markets. Where an investment product invests in derivative instruments, this entails specific risks that may increase the risk profile of the investment product. Where an investment product invests in a specific sector or geographical area, the returns may be more volatile than a more diversified investment product. Franklin Templeton accepts no liability whatsoever for any direct or indirect consequential loss arising from use of this document or any comment, opinion or estimate herein. This document may not be reproduced, distributed or published without prior written permission from Franklin Templeton.

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