The Rate Cycle That Changed Everything
The Federal Reserve’s interest rate hiking cycle of 2022-2023 — 11 rate hikes taking the federal funds rate from 0-0.25% to 5.25-5.5% in 18 months — was the most aggressive monetary tightening in 40 years. The Bank of Canada followed a similar trajectory, taking its overnight rate to 5.0%. The era of free money, which had defined financial markets since 2008, came to an abrupt end. And then, in September 2024, the Fed began cutting — 50 basis points to start, followed by additional cuts. Where are we now, and what comes next?
Inflation: Tamed But Not Vanquished
US CPI inflation peaked at 9.1% year-over-year in June 2022 — the highest since November 1981. By late 2024, it had fallen to the 2.4-2.9% range, a dramatic decline but still above the Fed’s 2% target. Core PCE — the Fed’s preferred measure — has followed a similar trajectory: from a peak of 5.6% in early 2022 to around 2.6-2.8% in late 2024.
The “last mile” of inflation — getting from ~2.8% to the 2% target — has proven stubborn. Housing costs (shelter is about 34% of CPI) remain elevated because official measures lag real-time rent data by 12-18 months. Services inflation, driven by wage growth, has been persistent. Energy prices are volatile and geopolitically sensitive. The Fed is walking a tightrope: cut too fast and inflation reignites; cut too slowly and the economy tips into recession.
What Rate Cuts Mean for Markets
Rate cuts are generally bullish for stocks, but not universally. The nuance matters: rate cuts driven by falling inflation with a still-healthy economy (the “soft landing” scenario) are very bullish — this was the 1995 playbook, and markets loved it. Rate cuts driven by a rapidly weakening economy (the “recession panic” scenario) are bearish — this was 2001 and 2007, and markets hated it.
The Fed’s 50 bps cut in September 2024 landed in a gray zone. Inflation was falling, which was good. But why the urgency? A 50 bps cut to start a cutting cycle is historically unusual outside of crises. The Fed described it as a “recalibration” not a panic move, and markets initially rallied. But the data-dependent nature of subsequent cuts means every jobs report and CPI print becomes a binary event for traders.
Bonds benefit most directly from rate cuts. When rates fall, existing bonds with higher yields become more valuable. The Bloomberg US Aggregate Bond Index, which had its worst year in history in 2022 (down 13%), delivered solid positive returns in 2023 and 2024 as rates stabilized and began declining. The 60/40 portfolio, pronounced dead in 2022, is making a quiet comeback.
Real Rates and Asset Valuation
The concept that matters most for asset prices is real rates — nominal rates minus inflation expectations. At the peak of tightening in 2023, real 10-year Treasury yields hit roughly 2.5%, the highest since before the 2008 financial crisis. Positive real rates make bonds competitive with stocks for the first time in years, which mechanically compresses equity valuations (higher discount rates = lower present value of future earnings).
As of early 2025, real 10-year yields are around 1.5-2.0%, lower than the peak but still well above the negative real yields that characterized the 2010-2021 period. This is a “normal” interest rate environment — something that feels abnormal to anyone who started investing after 2008.
Correlation Analysis: Stocks and Bonds
Stock-bond correlation is the single most important macro variable for portfolio construction. When stocks and bonds are negatively correlated (bonds go up when stocks go down), bonds provide a hedge. This was the dominant regime from roughly 2000 to 2020. In 2022, the correlation flipped positive — stocks and bonds fell together as the Fed raised rates aggressively. For investors accustomed to bonds as a ballast, this was a brutal wake-up call.
In 2024-2025, the correlation has been inconsistent — negative during inflation scares, positive during growth scares. The driver of the correlation regime is inflation volatility. When inflation is stable and low, stocks and bonds are negatively correlated (the “Fed put” is reliable). When inflation is volatile, stocks and bonds become positively correlated (the Fed can’t cut to save markets without risking inflation).
The macro regime of 2025 is one of higher-for-longer rates, gradual disinflation, and moderate economic growth. It’s not the worst environment for investors, but it’s also not the “TINA” (There Is No Alternative to stocks) era of 2010-2021. Cash earning 4%+ is a real option. Bonds yielding 4%+ are a real option. Stocks need to earn their premium, and that’s actually healthy — markets where everything goes up regardless of fundamentals are the ones that end badly.