Asset management giant Vanguard: The market has overestimated the pricing of the Federal Reserve's interest rate cuts

Global asset management giant Vanguard believes that the "massive" spending boom on artificial intelligence infrastructure will drive strong growth in the U.S. economy, and the Federal Reserve's rate cuts will be far lower than Wall Street's expectations.

In a recent interview with the Financial Times, the company's head of fixed income, Sara Devereux, predicted that after two 25 basis point rate cuts this fall, the Federal Reserve will only cut rates one to two more times.

This hawkish forecast sharply contrasts with market bets. Investors currently expect the Federal Reserve to cut rates three to four times by the end of 2026, while Devereux, who manages $2.8 trillion in assets, stated that "the market has over-priced the Federal Reserve's rate cuts." She anticipates that interest rates may reach neutral levels by "mid-next year."

Devereux noted that AI capital spending is expected to grow by about 8% this year, and this "significant growth" will support economic growth in 2026, thereby limiting the Federal Reserve's ability to ease policies without triggering inflation. Meanwhile, she warned that the corporate bond market faces oversupply pressure but believes that recent defaults are isolated incidents.

AI Spending Boom Reshapes Growth Expectations

Vanguard has significantly raised its U.S. GDP forecast based on the continued growth of AI infrastructure spending. Devereux stated that the company expects the U.S. economy to grow by 1.9% this year, but to accelerate to 2.25% by 2026.

"I think the biggest takeaway from this earnings season may be AI capital spending," Devereux said, "We have significantly raised our GDP forecast primarily based on this." The company expects AI capital spending to remain near current high levels next year.

This optimistic outlook on AI spending contrasts with recent investor concerns about excessive gains in tech stocks. The tech-heavy Nasdaq Composite Index has fallen about 7% this month, and bonds issued by large tech companies have also declined.

Corporate Bond Market Faces Oversupply Challenges

Devereux warned that corporate bond prices may be impacted in the coming months as the market needs to digest a large volume of bond issuance from companies including Amazon, Meta, Alphabet, and Oracle. According to JP Morgan, corporate bond issuance is expected to reach $1.8 trillion by 2026.

"We have been overweighting credit bonds, but the degree of overweighting is below the average level during the cycle," Devereux stated, "Valuations are tight, and the supply is very, very large."

Despite facing supply pressures, Devereux believes that the recent bankruptcies of subprime auto finance company Tricolor and auto parts company First Brands may be isolated incidents and do not represent a broader market crisis. She stated, "We will see some defaults in the private credit space; this is a year of discipline and precision, not all boats will rise."