Market expectations of US Fed actions signal a worrisome growth outlook

By most measures, it has been a chaotic year in financial markets and consequently a difficult time for decision-makers.

- Arup Raha

Under normal circumstances, the US tariffs and the uncertainty around US economic policy should have led to a stronger US dollar. But that has not happened this time. If the financial markets are right about how US policy is likely to play out, the growth outcome in the US is likely to be worse than expected.

(PHOTO: BLOOMBERG)

One such decision appears to have been resolved on Sept 17 as the US Federal Reserve cut the policy rate for the first time in 2025.

It was a small 25 basis point (bp) move and the financial markets cheered it. Or at least, they cheered it for a while, until it probably dawned on them that the Fed was cutting rates even with inflation well above its informal target of 2 per cent.

Moreover, the financial markets expect another 50 bps of rate cuts in 2025, and two more cuts of 25 bps each in 2026.

There are two possibilities that could drive such action. One, that the Fed thinks inflation is transitory and so it may not be that important in the short run.

Therefore, it is likely to be squarely focused on the growth outcome. This equation would change if inflationary expectations remain stubborn, thus feeding into wage expectations and contracts.

In that event, the Fed cannot really cut rates, and, depending on how insidious inflation becomes, it may even be forced to raise them.

Interestingly, one member of the Fed’s Open Market Committee signalled an expectation for the Fed fund rate to be increased from its current level by the end of 2025. Of course, this view was an outlier, but it does show that concern about inflation exists, even if markets are largely ignoring it.