Vanguard says traders are expecting far more Fed rate cuts than are likely

Vanguard says Wall Street is getting ahead of itself on Fed rate cuts. The firm’s fixed-income boss, Sara Devereux, who manages $2.8 trillion, said she only expects one or two more cuts after the two quarter-point ones already delivered this fall.

That’s nowhere near the three to four cuts the market is still pricing in before 2026 wraps up.

“Too many Fed cuts are priced into the market right now,” Sara told the Financial Times. “The market is over-relying on that.” She added that rates could reach a “neutral” point, where they neither push growth forward nor slow it down, by mid next year. That would seriously limit how far the central bank can go with easing.

At the same time, the Fed is split on what to do next. They’re watching labor market weakness and sticky inflation while growth remains steady. The debate on a possible December rate cut has cooled in recent weeks. That shift in mood has helped push stocks lower as investor hopes started fading.

Vanguard sees U.S. GDP landing at 1.9% for 2025, but then climbing to 2.25% in 2026, thanks to a huge spike in artificial intelligence investment. That spending, Sara said, “would continue rising at a blistering pace.”

Her team raised forecasts sharply after this last earnings season. “I think that probably the biggest epiphany we had from this earnings season was on AI [capital] spending,” she said. “We took our GDP forecast up a lot and it was really mostly based on that.”

AI investment limits room for policy easing

Spending on AI infrastructure has jumped roughly 8% this year, a number Sara called a “massive increase.” That level is expected to stick around through 2025. According to her, that wave of tech capex (chips, data centers, and cloud platforms) will keep boosting growth. That makes the Fed’s job harder. With stronger GDP, rate cuts risk sparking more inflation.

Not everyone’s convinced. Some investors think the tech rally is burning out. The Nasdaq Composite is down 7% this month, and debt tied to major tech companies has slumped. But Sara isn’t backing off her growth call.

Still, she warned that corporate bonds are probably heading lower as markets adjust to massive new issuance from firms like Amazon, Meta, Alphabet, and Oracle. JPMorgan thinks total corporate bond issuance in 2026 could hit $1.8 trillion.

There’s more going on behind the curtain. Lisa Cook, a Fed board governor, raised alarms on Thursday over hedge funds using basis trades to chase small price differences in Treasury markets.

“Outside of episodes of stress, relative value trades substantially improve the efficiency and liquidity of Treasury securities and related markets,” Lisa said. “Yet, during episodes of stress, the unwinding of crowded positions in such trades could magnify instability in these markets.”

That warning comes as data shows Cayman Islands-based hedge funds have soaked up more Treasury issuance between 2022 and 2024 than all other foreign private holders combined. Their holdings of Treasury cash securities climbed to 10.3% in Q1, higher than the 9.4% pre-COVID peak.

These funds borrow heavily to make small gains between Treasury cash and futures markets.

That strategy has already triggered two major crises, the 2019 repo meltdown and the March 2020 COVID panic, both of which forced the Fed to step in. Lisa said this time the risk is back and growing.

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