But Should the Fed Cut? (Maybe Not.)

Highlights

• Markets are convinced a cut is imminent, but the Fed’s mandate is the economy, not investor sentiment.
• Inflation remains above target, with core measures showing little progress and risk-asset exuberance suggesting excess liquidity.
• Labor market data (NFP, JOLTS, initial claims) are weakening, offering the only substantive case for easing.
• Political pressure from both the White House and Congress risks undermining the Fed’s independence.
• Emerging-market history warns that cutting too soon erodes credibility, fuels inflation, and ultimately hurts employment.

____________________________________________________________________________________________________________________________________

Inflation: The Stubborn Adversary

Inflation remains above target and, more worryingly, the trend is not improving. Tariffs are beginning to seep into producer costs and are gradually passing through to consumer prices. We focus on core data to strip out food and energy volatility, noting that producer prices (PPI) often lead consumer prices as companies adjust margins to higher input costs.

Meanwhile, financial conditions hardly look tight. Cryptocurrencies trade as if liquidity is abundant, while spreads in non-investment-grade credit are compressed to levels suggesting investors are climbing the risk ladder in search of yield. These are signs of excess. Cutting into that backdrop risks fueling inflationary momentum just as it threatens to re-accelerate.

We stress the tightening of high-yield spreads over Treasuries, which we see as one of the most information-dense, market-driven datapoints. The premium demanded from non-investment-grade corporate issuers (below BBB- for S&P, Baa3 for Moody’s) relative to Treasuries reflects two dynamics:

• Liquidity signal. Conventional asset classes — blue-chip equities, Treasuries — are absorbed first. When liquidity spills into riskier pockets such as small-caps, EM equities, and finally high-yield debt, it is a sign the market is flush with cash.
• Relative unattractiveness of Treasuries. When investors accept higher credit risk to capture yield, they are signaling that sovereign paper no longer offers an adequate return.

Employment: The Weak Link in the Chain

The counterweight is the labor market. Forward-looking indicators like Nonfarm Payrolls (NFP), the Job Openings and Labor Turnover Survey (JOLTS), and initial jobless claims all point to mounting weakness. One caveat: both NFP and JOLTS are survey-based with inherent lag and frequent revisions. Even so, the picture is consistent: job creation is slowing sharply, and openings are undershooting expectations.

The causes may vary — reduced immigration, declining investment, structural shifts — but the reality is unchanged: job creation is waning, and the Fed cannot ignore it. For policymakers, employment weakness remains the only tangible justification for easing.

Politics in the Room

The most visible pressure today comes from the Executive Branch. President Trump has been explicit in calling for deeper and faster easing, urging the Fed to “cut bigger, cut now” ahead of the FOMC’s decision. That level of presidential intervention underscores how politics intrude on monetary policy.

But this phenomenon is not unique. In 2024, Democratic senators Elizabeth Warren, Sheldon Whitehouse, and John Hickenlooper formally pressed the Fed to slash rates by 75 basis points. The dynamic is bipartisan: elected officials seek short-term economic relief, even at the risk of complicating the inflation fight.

The common thread is credibility. Once the Fed appears to bend to political demands, independence erodes — and with it, the effectiveness of monetary policy. Credibility lost is painfully expensive to rebuild.

Lessons From Emerging Markets

History offers a warning. In many emerging economies, central banks that yielded to political pressure and cut prematurely paid a steep price. Inflation flared, credibility vanished, and unemployment spiked anyway. The sequence is predictable: inflation control is lost first, the real economy follows into disarray, and stability becomes vastly harder to restore once expectations de-anchor.

Conclusion: Priorities Matter

The Fed faces a difficult choice. Markets expect accommodation, employment data argue for caution, and politics demand action. But inflation remains the greater threat. To cut now risks repeating a familiar policy mistake: easing into a fragile disinflation, only to lose control of prices and credibility.

In the end, losing the battle against inflation by cementing entrenched expectations is far riskier than tolerating a temporary rise in unemployment. The lesson is clear — protect stability first, support growth second.

____________________________________________________________________________________________________________________________________

© 2025 Securities are offered by Lime Trading Corp., member FINRA, SIPC, NFA. All investing incurs risk including, but not limited to, the loss of principal. Additional information may be found on our Disclosures Page. The material in this communication is not a solicitation to provide services to customers in any jurisdiction in which Lime Trading is not approved to conduct business. The material in this communication has been prepared for informational purposes only and is based upon information obtained from sources believed to be reliable and accurate; however, Lime Trading Corp. does not warrant its accuracy and assumes no responsibility for any errors or omissions. The information provided is not an offer to sell or a solicitation of an offer to buy any security or a recommendation to follow a specific trading strategy. Lime Trading Corp. does not provide investment advice. This material does not and is not intended to consider the particular financial conditions, investment objectives, or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.