We outline four potential areas for investors to think about as interest rates continue to decline
Are you better off being defensive or bullish?
Reductions in interest rates aren't always reason for celebration for investors. Rate reductions reduce borrowing costs, which relieves pressure on people and businesses, but they can also be a sign that the economy is not doing well.
Economists and investors have been making predictions about the possibility of a "soft landing" for the last three years. In order to combat inflation, could central banks raise interest rates just enough before lowering them to avoid a recession?
For a time, the image appeared promising. The stock market appeared to be doing well, and economies showed surprising resilience to higher rates. Following a challenging year in 2022, the SandP 500 produced consecutive returns of over 20 percent in 2023 and 2024. Global stocks didn't lag too much.
In spite of this, in recent weeks, the situation has grown increasingly complicated. Businesses, households, and investors have been alarmed by US President Donald Trump's unpredictable tariff policies, which could increase inflation and impede economic expansion.
Even though interest rates are still a significant factor for investors when building their portfolios, it is impossible to benefit from the changing interest rate landscape without first taking the most recent geopolitical events into account.
First, the pace and scope of rate cuts will be impacted by geopolitical developments. Second, they will have an impact on their surroundings. Stated differently, are central bankers reducing rates because growth has become a concern or because inflation has stabilized?
Depending on these factors, investors' stance will either be defensive or bullish.
1. Gold
Given the current state of interest rates, gold might become more appealing. Since gold doesn't pay interest, its value increases relative to cash yields, so when interest rates are lowered, the price of gold tends to rise. So far this year, the price of gold has risen approximately 11%, continuing to reach new highs.
Gold bugs will tell you that having the yellow metal in your portfolio is always a good idea, regardless of interest rate considerations. Because it retains its value well, it can serve as an inflation hedge. Additionally, it offers good potential for diversification due to its low correlation with equity markets.
The asset is still in high demand, and future safe-haven purchases may drive it even higher. According to the World Gold Council, physically-backed gold ETFs saw the largest inflows since March 2022 in February, with £9.4 billion.
Trump's tariffs have raised market volatility and uncertainty recently, which increases the possibility that gold will be seen as a safe-haven asset. Gold has historically been a dependable investment during uncertain times because of these factors, according to Rick Kanda, managing director of The Gold Bullion Company.
Here is a list of the top gold ETFs compiled by BFIA.
2. Ties
Because the coupons on existing bonds begin to appear more appealing than those on new issues, bond prices typically increase when interest rates decline. The asset class might be worth a look given the anticipated additional interest rate reductions throughout 2025. Since yields are still high, a respectable income level is also available.
A variety of factors, such as duration and credit quality, should be taken into account when deciding which types of bonds (or bond funds) to include in your portfolio. Investors may want to choose more creditworthy segments of the market as recessionary risks increase. Developed market government bonds or premium investment-grade corporate bonds, where default risk is low, may fall under this category.
The current tightness of credit spreads, or the premium investors receive for taking on greater credit risk, is another factor in the decision to choose more creditworthy bonds. Put differently, investors are not receiving a commensurate amount of money for purchasing riskier bonds.
In terms of duration, some could argue that buying bonds with longer maturities will "lock in" higher interest rates for a longer period of time. This strategy could be risky, though, as inflationary pressures are starting to heat up once more.
Senior fixed income analyst George Martin of wealth management company Charles Stanley stated, "The market volatility of longer-dated bonds can result in significant swings in value, even though they have high yields that can be locked in." His preferred duration of bonds is therefore between two and three years.
Bonds are more susceptible to shifts in inflation expectations the longer they have been in circulation. In spite of the bonds' high yield on paper, Martin continued, "longer-dated bonds therefore carry a higher level of risk, and in a world where inflation doesn't get back to the central bank's 2 percent target, investors could see losses."
3. UK dividend stocks
. When interest rates decline, bond prices will rise, but the amount of income available in the bond market will begin to decline. This also holds true for cash yields. Over the past 12 months, the savings market has already witnessed a flurry of interest rate reductions. As this happens, income-dependent investors might want to think about increasing their holdings of dividend-paying stocks.
Dividend stock is thriving in the UK market. The FTSE 100 currently offers a 3-point-eight percent 12-month forward dividend yield, according to Factset data. The FTSE 350 is up 2.9 percent, a little more. Ten-year government bonds, which are currently yielding 4.7 percent, are not far behind this. In the domestic market, share buyback activity has also increased recently, indicating that investors are receiving a larger real cash return than the dividend yield would indicate.
"The UK equity market has so far in 2025 offered more dividend increases than it has cut, more share buyback announcements in value terms than at the same stage in 2024, and more positive surprises than negative ones," stated Russ Mould, platform AJ Bell's investment director. This is all in spite of what at first glance seems to be a dark macroeconomic and tense geopolitical environment.
If the domestic market maintains its strong share price performance from the beginning of the year, you may also profit from capital growth. Despite recent declines in global stock markets, the FTSE 100 has increased by about 3% so far this year. In comparison, the S&P 500 has experienced a decline of nearly 5% during the same time frame.
Alternatively, dividend stocks may prove to be a defensive investment in the event of a market decline. Good financial discipline is frequently indicated by a company's ability to pay shareholders a dividend that is steady or increasing over time.
4. If you have a more optimistic outlook for small-cap growth, continue reading
Less defensive market segments may be of interest to those who have a more positive outlook on the economy. For instance, small-cap stocks might be worth a look if you believe that recessionary fears are exaggerated.
Generally speaking, smaller companies suffer when interest rates and inflation are high. It can be more difficult for them to swallow price increases and they are often more leveraged (and more exposed to floating-rate debt) than their larger counterparts. They may rise as interest rates decline and inflation is brought under control.
According to research released earlier this month by the international investment firm Aberdeen, UK small caps present unique opportunities because they are trading at a discount of over 24% to their 10-year average.
However, it is important to note that they may suffer from the higher labor costs that will be incurred starting in April. According to Mould, "smaller businesses may find it more difficult to adapt to the increased costs brought by the higher minimum wage and higher national insurance contributions."
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