Things have gone from bad to worse in a hurry on Wall Street, with the S&P 500 (^GSPC -1.39%) joining the Nasdaq Composite (^IXIC -1.96%) in correction territory on Thursday. The leading market index has fallen 10.1% in just three weeks’ time. Despite a two-plus-year bull market that lifted stock valuations to lofty elevations, market strategists came into 2025 with generally positive outlooks. However, weakening economic data and President Donald Trump’s trade war have thrown the market into disarray. Investors are increasingly concerned about the possibility of a recession or even stagflation.
In light of all these fresh economic headwinds, it’s natural to wonder: Will the Federal Reserve resume cutting interest rates soon to provide some stimulus?
The odds of cuts have increased
The Federal Reserve began cutting interest rates last year after its previous rate-hiking campaign succeeded in significantly reducing the U.S. inflation rate. With its concerns shifting toward the impact of higher interest rates on the labor market, the Federal Open Market Committee (FOMC) cut the benchmark federal funds rate by 50 basis points (half of a percentage point) at its September meeting, followed by a cut of 25 basis points at its November meeting.
Data up until very recently has shown that inflation was beginning to reaccelerate, which put an obstacle in the way of further rate cuts: The Fed doesn’t want to overstimulate the economy and risk reigniting high inflation. The Fed also acknowledged in past meeting minutes that it has been waiting to see how Trump’s policies related to immigration and tariffs end up affecting the economy.
Many expected that the president’s policies would be inflationary, but so far, weaker economic data, including a worsening labor market and lower revised gross domestic product estimates, have sent Treasury yields downward. Traders betting on the outlook for the federal funds rate have gone from penciling in zero or maybe one 25-basis-point rate cut this year to expecting (on average) three such cuts this year (as of Wednesday morning). Keep in mind that these predictions are constantly changing.
The Fed doesn’t want to see further deterioration in the labor market, but it could be difficult to cut interest rates if inflation doesn’t continue to fall toward its preferred 2% target because the combination of rising unemployment and high consumer prices can lead to slow economic growth and create a scenario known as stagflation. That would put the Fed in a bind because if it cuts rates, inflation could accelerate, but if it raises rates, unemployment is likely to keep climbing. Investors are likely to fear stagflation more than a modest recession because the Fed can fight back against recessionary conditions by cutting interest rates, which is often good for stocks.
Investors recently got a more positive update after new data showed that inflation slowed more than expected in February. The Consumer Price Index rose 0.2% from the prior month and was up 2.8% year over year, with both numbers coming in 0.1% below estimates.
Will the Fed step in?
The FOMC has been monitoring economic data as well as the policies implemented by the Trump administration, and I suspect the committee will stay on its current path for the next few months.
Adding difficulty to its task is that Trump is laying off federal workers, closing programs, and halting previously approved federal spending, all of which not only impacts federal employees but also government contractors and others in ways that will impact the U.S. job market. Furthermore, Trump has repeatedly gone back and forth on a host of tariffs; investors have no idea whether they are being used as a short-term negotiating tactic or whether those higher taxes on imported goods will be here to stay long-term. Trump has clearly gone further than the market expected, and he and Treasury Secretary Scott Bessent have warned that Americans should expect to feel some pain as he uses tariffs to pursue his goals.
I don’t expect the Fed to make a change to the federal funds rate at its upcoming March meeting, but it’s possible that conditions that justify interest rate cuts will come into view over the next few months. If U.S. economic data remains weak, inflation softens, and stagflation concerns fade, an interest rate cut may be on the table at the FOMC’s May or June meetings.
Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
