The Fed Rate Cut Everyone Expects

The Federal Reserve finds itself at a critical juncture. Markets have been pricing in a 25 basis point cut for September, and expectations are running so high that anything other than this outcome would shock investors. Yet history reminds us that central banks rarely move in perfectly predictable ways.

What happens if the Fed decides to cut by 50 basis points instead? What if they do not cut at all? Should they even cut in the first place? And more importantly, what would these decisions mean for markets, the economy, and the Fed’s credibility going forward?

This episode takes a closer look at these scenarios.

The Expected Path: A 25 Basis Point Cut

Markets currently assign overwhelming odds to a 25 basis point reduction in the federal funds rate. This move would be seen as the safe path, one that balances the need to support a weakening labor market with the need to avoid reigniting inflationary pressures.

A quarter point cut would signal that the Fed acknowledges the economic slowdown, especially after the recent weak jobs report and the massive downward revision to past employment data. At the same time, it would allow policymakers to frame the cut as a cautious adjustment rather than an aggressive shift.

Markets would likely react with relief, confirming expectations that are already priced in. Stocks could see a short-term rally, bond yields might continue to drift lower, and the dollar could weaken slightly. Yet because this is the baseline expectation, the upside for markets might be limited.

The Surprise of a 50 Basis Point Cut

Now imagine the Fed shocks everyone and delivers a 50 basis point cut. At first glance, markets would likely cheer. Stocks could surge, bond yields might fall sharply, and risk assets across the globe would get a boost. A move of this magnitude would be interpreted as the Fed acknowledging that the economy is in much worse shape than previously admitted.

But such a cut carries risks. By moving this aggressively, the Fed would be signaling that it sees deep structural weakness or an imminent threat to financial stability. While investors love easy money in the short term, they would also begin asking uncomfortable questions. What is the Fed so worried about? Do they see cracks in the banking system or credit markets that are not yet visible to the public?

History tells us that outsized cuts often reflect emergency conditions. A 50 basis point move might soothe markets for a few days but could ultimately stoke fear that the Fed knows something we do not. This could create volatility rather than stability.

What if They Do Not Cut at All

The most shocking outcome of all would be no rate cut. While highly unlikely, it cannot be ruled out entirely. If the Fed held rates steady, markets would sell off sharply. Stocks would fall, bond yields would spike, and the dollar would strengthen as investors scrambled to adjust positions.

The Fed could justify such a move by pointing to the recent uptick in inflation data. After all, the central bank’s dual mandate requires both maximum employment and price stability. If inflation remains sticky or resurges, the Fed might decide it is too risky to cut, even with weakening labor data.

But the consequences of this decision would be profound. It would shatter market expectations and damage the Fed’s credibility. Investors would begin to question whether the Fed’s forward guidance can be trusted at all. Businesses and households, already facing uncertainty, would pull back further on spending and investment.

No cut would likely trigger a broader tightening of financial conditions and raise the risk of recession.

Should They Cut at All

The bigger question is whether the Fed should cut in the first place. On one hand, the case for easing is clear. The labor market has softened, revisions to job growth show the economy has been weaker than believed, and financial conditions remain tight. Inflation, while not fully conquered, has moderated significantly from its peaks.

On the other hand, inflation has recently ticked higher in both CPI and PPI reports. Cutting too soon risks undoing progress made in the fight against rising prices. Once inflation expectations become unanchored, they are extremely difficult to rein in. The Fed still remembers the painful lessons of the 1970s when premature easing led to runaway inflation.

The decision therefore comes down to weighing two risks. Cut too aggressively, and inflation could return. Hold too tight for too long, and the economy could fall into recession.

Where We Go From Here

Regardless of whether the Fed cuts by 25 basis points, 50 basis points, or not at all, the larger issue is the path forward. Rate policy is only one part of the picture.

Several key dynamics will shape the outlook:

• Labor market trajectory: Continued weakness will keep pressure on the Fed to cut further. Any stabilization or rebound could delay additional easing.

• Inflation trends: Even small upticks in inflation will complicate the Fed’s ability to deliver consistent rate cuts.

• Bond market response: If both short and long term yields continue to fall, it will signal confidence in the Fed’s policy path. If long term yields rise even as the Fed cuts, it would suggest waning trust in the United States.

• Global pressures: Slowing growth in Europe and China, combined with geopolitical risks, could amplify the impact of Fed decisions.
  
  

A Hypothetical Risk Nobody Wants to Consider

For now, both short and long term rates have fallen after the weak job report. This is the normal and expected reaction. But what if, over time, the long end of the curve rises even as the Fed continues to cut the short end?

This would signal a loss of confidence in the United States. Investors in global bond markets would be demanding higher compensation to lend long term, either because they fear inflation or because they question America’s fiscal discipline.

Such a divergence would be disastrous. Mortgage rates and corporate borrowing costs are tied more closely to long term yields. If those yields rise while the Fed cuts, it would mean easier money on one end but tighter conditions on the other. Credit would not flow, investment would dry up, and the economy could grind to a halt.

How likely is this scenario? At present, not very. The US dollar remains the world’s reserve currency and US Treasuries are still considered the safest asset on the planet. But history shows that confidence can erode faster than many expect. A combination of high deficits, political dysfunction, and inflationary pressure could push global investors to demand higher yields.

The Fed can control the short end of the curve. It cannot control the long end forever.

Conclusion

The September Fed meeting is about more than a 25 basis point cut. It is about credibility, expectations, and the path ahead for both markets and the economy.

A small cut would meet expectations but do little to change the bigger picture. A larger cut could spark short term euphoria but long term doubt. No cut at all would shock markets and risk recession.

More important than the immediate decision is what comes next. The bond market, the labor market, and inflation trends will determine whether the Fed can thread the needle or whether it risks losing control.

The world is watching.