Global Liquidity Reset As Curve Steepens

Markets are now pricing two additional 25bp Federal Reserve cuts in 2025, taking the target range toward 3.75%–4.00% by mid-December. The timeline aligns with the 28–29 October and 9–10 December FOMC meetings. The macro backdrop justifies recalibration: the U.S. unemployment rate printed 4.3% in August 2025, up roughly 60bp from its 2023 trough, while 12-month PCE inflation ran about 2.7% and core disinflation slowed on services. With the two-year Treasury yield near 3.46% on 20 October and the 10s–2s slope positive around 54bp, financial conditions have already pivoted from deeply inverted to mildly steep, indicating that policy is transitioning from restrictive toward neutral rather than into outright stimulus.

Transmission is straightforward. Lower policy rates pull down the entire front end, compressing real short rates and reducing the expected policy path embedded in two-year notes. A 50bp cumulative cut, if delivered, typically trims investment-grade borrowing costs by 15–25bp absent risk-off shocks and lifts primary issuance by bringing forward liability-management windows. For banks, a move from a −30bp to +50bp curve over 3–10 years historically supports net interest margins as asset yields reprice faster than deposit betas. Duration assets benefit as discount rates fall: long Treasuries gain if real yields drift lower, while convexity can bite if breakevens widen. Credit spreads tend to compress into benign easing cycles; the key test is whether high-yield defaults remain contained near the low-4% handle rather than re-accelerating.

Global relevance is immediate. World growth around 3.0% in 2025 remains below the pre-2010 3.8% average, and debt ratios are higher. A softer U.S. rates profile narrows the dollar’s carry advantage and loosens external financing conditions for credible emerging markets. Historically, a 50bp decline at the U.S. front end coincides with a 20–35bp tightening in EM hard-currency sovereign spreads, which can shave interest outlays by roughly 0.1%–0.3% of GDP for issuers with external debt near 30%–40% of GDP. The mechanism is conditional: countries with independent monetary policy, transparent fiscal anchors, and adequate reserves convert easier global conditions into lower term premia; those with weak anchors import volatility via FX and inflation pass-through.

Market positioning reflects these mechanics. U.S. equity multiples gain from lower discount rates, but earnings sensitivity matters: margins remain below the post-2010 mean in several cyclicals, so valuation expansion without productivity improvement risks mean-reversion.

In rates, long duration (TLT) participates if the five-year TIPS-implied real yield trends lower and breakevens stay contained. In credit, quality beta (LQD) benefits most from all-in yield compression; high-yield (HYG) performance hinges on refinancing calendars concentrated in 2026–2027. A softer broad dollar supports EM risk (EEM) provided policy credibility and terms-of-trade are stable. Commodities respond asymmetrically: oil (CL=F) tracks growth and inventory cycles more than rates; gold sensitivity ties primarily to real yields and dollar direction, keeping XAUUSD bid if real rates fall and the dollar eases.

Policy credibility remains the fulcrum. The Fed can ease while preserving its inflation anchor if medium-term expectations hold near 2.3%–2.6% and wage growth converges toward productivity. If expectations drift toward 3% or unit-labour-cost growth persistently exceeds productivity by more than 2 percentage points, the easing sequence risks truncation as term premia rebuild and the dollar re-firms. Fiscal arithmetic intersects the cycle: with higher debt stocks, any rise in long real yields tightens the interest-growth differential (r–g), raising debt-stabilisation thresholds and crowding out private investment. That feedback loop argues for measured cuts, not an unconditional pivot.

The forward test is specific and time-bounded. Through Q1-2026, confirm three conditions: the 10s–2s slope sustains a +25bp to +75bp corridor; five-year-five-year inflation expectations remain within 2.0%–2.6%; and the trade-weighted dollar eases by 2%–4% on a rolling quarter. Concurrently, track monthly IG primary volumes above $150bn without widening new-issue concessions, high-yield defaults capped near 4% annualised, and non-farm payroll growth averaging 75k–125k alongside core PCE trending closer to 2.5%.

If these thresholds hold, the soft-landing path remains intact, supporting duration, quality credit, and selective equity risk. If two or more break—reaccelerating breakevens, a re-inversion of the curve, or a dollar rebound—the market will price a shorter easing cycle, wider risk premia, and heavier refinancing frictions into 2026.