The Fed's September Rate Cut: High Probability and Strategic Portfolio Positioning

Bottom Line Up Front: Markets are pricing in an approximately 90% chance of a Federal Reserve rate cut in September 2025, driven by weaker-than-expected employment data and evolving economic conditions. Investors should consider repositioning portfolios to benefit from this likely shift in monetary policy.

Current Market Expectations

The probability of a Federal Reserve rate cut at the September 17-18, 2025 FOMC meeting has surged dramatically following disappointing economic data. According to the CME FedWatch tool, markets are currently pricing in an 89.4% probability of a 25-basis-point rate cut by the Federal Reserve when it holds its next meeting in mid-September, with some sources indicating probabilities as high as 93.6%.

This represents a significant shift from earlier in the year when rate cut expectations were more subdued. The catalyst for this change has been a series of economic data points that suggest the Federal Reserve’s cautious stance may be giving way to concerns about economic softening.

Key Drivers Behind Rate Cut Expectations

Employment Data Concerns

The primary driver of increased rate cut expectations has been disappointing employment data. July payroll growth came in far below forecasts, and May–June figures were revised down significantly, signaling deeper job market weakness. Specifically, the July jobs report found just 73,000 jobs created last month – well below the 110,000 estimate of economists polled by LSEG.

This employment weakness has shifted the Federal Reserve’s risk assessment. Softer labor market data, released two days after the Fed’s July meeting, increased the likelihood of a September Fed rate cut, as policymakers balance inflation concerns against potential labor market deterioration.

Fed Leadership Changes

Adding to the dovish sentiment, the resignation of FOMC member Adriana Kugler also opens the door for a more dovish Fed shift, providing President Trump with an opportunity to appoint a member more aligned with his preference for lower rates.

Inflation vs. Employment Trade-off

While inflation remains above the Fed’s 2% target, the central bank appears increasingly willing to balance these concerns against employment risks. Inflation remains higher than the Fed would like, but weaker hiring activity balances those risks and suggests less restrictive interest rate policy.

Expert Perspectives and Forecasts

Goldman Sachs Analysis

Goldman Sachs Research economists now expect the Fed may cut its policy rate in September, three months earlier than they had previously forecast. They cite several factors supporting this view:

• Early evidence suggests tariff policy effects are smaller than expected
• Disinflationary forces have been stronger than anticipated
• The job market shows signs of softening despite appearing healthy overall

Goldman Sachs economist David Mericle estimates that the odds of a rate cut in September are “somewhat above” 50%, with the team penciling in 25-basis-point cuts in September, October, and December.

Market Pricing and Future Expectations

Beyond September, markets are pricing in substantial additional cuts. Markets see rates being substantially lower than the current target range of 4.25% to 4.5% by the end of the year, with a 45.7% chance of 75-basis-points of cuts and a 42.6% chance of 50-basis-points from that level after the Fed’s December meeting.

This suggests investors expect not just a September cut, but a sustained easing cycle throughout the remainder of 2025.

Portfolio Strategy Implications

Fixed Income Positioning

Move Away from Cash: With rate cuts likely, the era of high-yielding cash investments is ending. When the Fed starts cutting rates, cash yields come down, making it crucial to redeploy cash into longer-duration assets.

Duration Strategy: Investors should consider extending duration in their bond portfolios. With the yield curve back to normal, “there are now meaningful benefits to extending duration” in portfolios. Consider intermediate-term bonds that can capture price appreciation as rates fall while maintaining reasonable risk levels.

Bond Sector Allocation:

• High-Quality Corporate Bonds: High-quality corporate debt offers attractive yield pickup over Treasuries
• High-Yield Bonds: Historically, over the economic cycle — recovery, expansion, slowdown and recession — high yield is the only sector that has outperformed in every phase
• Municipal Bonds: For taxable accounts, consider high-yield municipal bonds for tax-advantaged income

Equity Sector Positioning

Interest-Sensitive Sectors:

1. Real Estate (REITs): Real estate stocks benefit from lower borrowing costs, and the real estate sector also benefits from lower borrowing costs. Lower rates reduce financing costs for property acquisitions and development.

2. Utilities: Utilities stocks performed consistently well throughout 2025’s first half, driven by positive investor sentiment for utilities companies given the rapid growth in power demand by burgeoning data center development. These capital-intensive companies benefit significantly from lower borrowing costs.

3. Small-Cap Stocks: Smaller companies have historically outperformed large companies by nearly 5% on average a year after a rate cut. Small caps collectively rely more heavily on external financing than their larger-cap peers, so falling borrowing costs are a tailwind.

Growth vs. Value Considerations:

Growth stocks – particularly tech, small-caps and other companies dependent on expectations of future earnings – tend to benefit most from rate cuts. This occurs because:

• Lower rates reduce the cost of capital for growth companies
• Valuation math favors growth as lower rates increase the present value of future profits

Risk Management and Diversification

Quality Focus: During uncertain economic conditions, focus on quality. Large-cap stocks have performed almost twice as well as small-caps during soft landings, suggesting investors should focus on quality under either economic scenario.

Geographic Diversification: Consider international exposure, as diversification not only across equity geographies but also across asset classes can help capture pockets of outperformance.

Implementation Timeline and Considerations

Immediate Actions (Before September Meeting)

1. Reduce Cash Positions: Begin moving excess cash into short-to-intermediate duration bonds
2. Increase Duration: Gradually extend duration in fixed income allocations
3. Sector Rotation: Begin increasing exposure to interest-sensitive sectors

Post-Rate Cut Positioning

1. Small-Cap Allocation: Consider increasing small-cap exposure as rate cuts were delayed compared to initial market expectations at the beginning of 2024, small caps trailed large caps in the first half of the year
2. REIT Exposure: Increase real estate investment trust allocation
3. Utility Stocks: Consider utility sector exposure, particularly companies benefiting from AI-driven power demand

Risk Considerations

Economic Soft Landing vs. Hard Landing: Asset class performance has varied depending on why rates are moving lower: risk assets typically perform well during “soft landings” and suffer during “hard landings”. Current indicators suggest the Fed is attempting to engineer a soft landing, which would be favorable for risk assets.

Inflation Risks: Monitor inflation data closely. If CPI goes up by 0.3% or less, “that is a number that can probably be seen as acceptable for the Federal Reserve to proceed with a September cut”.

Conclusion

The convergence of weakening employment data, evolving Fed communication, and market pricing all point toward a high probability of rate cuts beginning in September 2025. With markets pricing in approximately 90% odds of a September cut, investors should position portfolios to benefit from this likely shift in monetary policy.

The key is to move deliberately but not drastically. Focus on extending duration in fixed income, rotating toward interest-sensitive equity sectors, and maintaining quality standards throughout the process. As rate cuts are coming, eventually, and certain sectors may benefit, but successful positioning requires balancing opportunity with prudent risk management.

Given the high probability of September action and the potential for a sustained easing cycle, the time to position portfolios for a lower-rate environment is now—before the cuts actually begin and these opportunities become fully priced into the market.

This analysis is based on current market conditions and expectations as of August 2025. Markets can be volatile and unpredictable, and past performance does not guarantee future results