Later today, the Federal Reserve is widely expected to cut rates for the first time in more than a decade. We expect a cut of 0.25% or 0.5%. This is largely priced in. But what happens next is important. Markets are pricing a total of 100bps of rate cuts by the end of 2020, in spite of still decent performance from the US economy and labor market.

We see three potential scenarios:

* The Fed’s renewed dovishness is part of a global trend in central bank policy, which has reversed from “gradual policy normalization” toward further rate cuts, in an effort to prolong the economic recovery and support inflation expectations. If successful, we can expect a continuation of the “Goldilocks” economy, with growth close to trend, moderate inflation and low rates.

* But if US economic data in the coming months is strong and market-based measures of inflation expectations stabilize and start to rise back towards the Fed’s inflation target, any lowering of rates this week may turn out to be an “insurance” cut, rather than the start of a more extensive easing cycle.

* For market pricing of Fed rate cuts to be proven right, a slowdown in growth would likely be needed. The risk to growth from uncertainty over trade is an important factor in the Fed’s decision-making and there is little sign of durable improvement. Renewed escalation in trade tensions, while not our base case, could prompt the Fed to deliver additional easing. But this would likely come amid more negative equity market sentiment.

So investors need to balance positioning that benefits from loose monetary policy, with positioning to protect against risks. A “Goldilocks” environment is positive for stocks and we position for this through a tactical overweight to equities, with a regionally selective approach. However, we expect returns in the second half of the year to be lower than in the first. Low rates also support carry trades, which help boost portfolio income. In our FX strategy, we overweight a basket of equally weighted high-yielding emerging market currencies against a basket of lower-yielding currencies. In addition, euro investment grade credit spreads should remain supported by an accommodative European Central Bank and we see good long-term value in emerging market sovereign bonds. To protect against the risk that fixed income markets may be overstating likely rate reductions we prefer cash and stocks to shorter-term US government bonds. And to protect against the risk of a growth slowdown we also retain some countercyclical positions.