For the past six months, if not longer, the U.S. market, particularly the S&P 500 and Russell 2000, has been running on hopes of a change in Fed monetary policy. More specifically, investors have been bracing for an interest rate cut. And now, the long-awaited moment could arrive this Wednesday, September 17.
However, the move will likely be much more cautious than President Trump has been pushing for. According to the CME FedWatch tool, there is a more than 90% probability that the move will be 25 bp, although the decision may not be unanimous, as some members could vote for a deeper 50-point reduction.
If, as markets expect, the Fed opts for a smaller hike, it will almost certainly provoke Trump's ire and fresh accusations that Chairman Powell is acting too slowly. Conversely, if a larger hike is announced, it could give stocks another boost, and the DXY could fall, as could Treasury yields.
The Federal Reserve's future direction will also be crucial. Investors will be looking for clues as to what might happen at the two remaining FOMC meetings this year. For example, Morgan Stanley and Deutsche Bank are forecasting two additional interest rate cuts: one in October and another in December.
So, what supports this scenario, and what pushes back against it?
On the supportive side, the U.S. labor market is showing signs of strain. In August, just 22,000 jobs were added — far fewer than expected. Earlier employment figures were revised sharply downward, with 911,000 fewer jobs reported through March 2025 than initially estimated.
The problem is that inflation is still not letting up. In August, energy prices rose 0.7% month-on-month and 0.2% year-on-year, while food prices accelerated 0.5% month-on-month and 3.2% year-on-year. Overall CPI increased 0.4% for the month and 2.9% year-over-year. Core inflation rose 0.3% and 3.1%, respectively.
The main factor driving this situation is the ongoing trade war. Goldman Sachs estimates that 86% of tariffs are being passed directly on to U.S. consumers, which in effect amounts to an additional tax on products. And the full impact on prices has not yet been reflected, suggesting that the problem is far from temporary.
In the worst-case scenario, the U.S. could fall into stagflation, i.e., a weakening of the labor market while inflation continues to rise. The Federal Reserve, like any central bank, wants to avoid this situation, so policymakers are unlikely to make hasty decisions.