Central Bank Policy and Market Volatility: Parsing Powell's Pivot and Inflation Risks

The Federal Reserve's September 17, 2025, rate cut—its first in nine months—has ignited a tug-of-war between market optimism and lingering uncertainty. By reducing the federal funds rate by 25 basis points to a range of 4–4.25%, the Fed signaled a pivot toward accommodative policy amid a cooling labor market and persistent inflation risksJerome Powell’s September 17, 2025 Press Conference – Notable Aspects^[1]. Yet, the mixed market reaction—with the Dow Jones Industrial Average rising 0.6% while the S&P 500 and Nasdaq Composite dipped—underscores the fragility of investor sentimentUS Stock Market Update: Fed Rate Cut Triggers Volatility on September 17, 2025^[2]. This analysis dissects how Powell's policy signals, coupled with upcoming inflation data, will shape equity and bond market volatility in the coming months.

Equity Markets: A Tale of Two Sectors

The Fed's rate cut was framed as a “risk management” move to cushion downside risks to employment, particularly as unemployment rose to 4.3% and job gains averaged just 29,000 per monthFederal Reserve lowers interest rates by 0.25 percentage points in 2025^[3]. While rate-sensitive sectors like housing and technology initially rallied, broader equity markets remained cautious. Defensive sectors such as utilities and consumer staples outperformed, reflecting a flight to safety amid economic uncertaintyFederal Reserve Cuts Rates by 0.25%, Signaling Caution Amidst Economic Shifts^[4].

However, the muted response suggests investors are grappling with conflicting signals. On one hand, lower rates should boost growth stocks by reducing discount rates for future earnings. On the other, Powell's warning that inflation remains “above target” and risks are “tilted to the upside” has kept volatility elevatedJerome Powell warns there’s ‘no risk-free path’ to avoid stagflation^[5]. The S&P 500's VIX index, a gauge of expected volatility, spiked post-announcement, illustrating this dualityEquity Market Volatility Tracker: Macroeconomic News and Outlook: Inflation^[6].

Bond Markets: Yield Curves and Inflation Jitters

The bond market's reaction was equally nuanced. The 10-year Treasury yield fell sharply after the rate cut, reflecting expectations of further Fed easing and a potential economic slowdownA key market data point is signaling fear about America’s economy^[7]. Yet, the 2-year yield—a proxy for short-term inflation expectations—rose by 4 basis points to 3.54%, signaling skepticism about the Fed's ability to sustain rate reductionsUS Treasuries Rally After Fed Delivers Quarter-Point …^[8]. This divergence has steepened the yield curve, a historically bearish signal for recessions, though some analysts argue it reflects positioning for a “belly of the curve” trade (favoring intermediate-term bonds over long-dated ones)Fed Rate Cuts & Potential Portfolio Implications^[9].

The Fed's cautious stance—projecting only two additional 25-basis-point cuts by year-end—has further muddied the waters. While Powell dismissed calls for aggressive action, dissenting FOMC member Stephen Miran advocated for a 50-basis-point cut, highlighting internal divisionsNavigating the New Era: Bond Market Braces for Volatility After …^[10]. This uncertainty has led to choppy trading, with bond yields oscillating as traders weigh the likelihood of a “hot” CPI report in OctoberBond-Market Bets on Deep Fed Cuts at Risk From Hot CPI Data^[11].

Inflation: The Wild Card

August 2025 CPI data, showing a 2.9% annual increase in headline inflation and 3.1% in core inflation, has become a focal pointCPI Shows Pace of US Inflation Likely to Keep Fed Cautious on …^[12]. While these figures represent a slowdown from earlier in the year, they remain stubbornly above the Fed's 2% target. Compounding concerns, household inflation expectations hit 4.3% for the 12-month horizon—the highest since late 2023—while longer-run expectations rose to 3.5%, a 30-year highInflation Expectations: On The Move Again? | Richmond Fed^[13]. This disconnect between market-based measures (which still anchor expectations at 2.24%) and consumer sentiment suggests a fragile equilibriumFOMC September 2025 press conference: Live coverage^[14].

The Fed's June 2025 projections, which assumed inflation would reach 2% by 2027, now look optimistic. Powell's acknowledgment that “there is no risk-free path” to balancing employment and inflation has amplified this doubtFed Cuts Rates for First Time This Year - The New York Times^[15]. If September's producer price data or October's CPI report surprises to the upside, the Fed's dovish pivot could unravel, triggering a sell-off in bonds and a rotation into cash or defensive equities2025 Bond Market Outlook: Yields Range-Bound but …^[16].

Looking Ahead: A Volatile Autumn

The coming months will test the Fed's credibility and markets' resilience. For equities, the key question is whether the rate cut spurs a sustained rally in growth stocks or if inflation fears reignite, dragging the market lower. For bonds, the yield curve's steepness and positioning for further Fed cuts will remain under pressure, particularly if Trump-era tariffs or immigration policies inject new inflationary shocksFixed Income Mid-Year Outlook (2025) | Charles Schwab^[17].

Investors should brace for volatility. Powell's speech may have provided a temporary reprieve, but the path to a “soft landing” remains fraught. As one analyst put it, “The Fed is walking a tightrope between a recession and runaway inflation—and the rope is fraying.”What the Fed’s Rate Cut Means for Bond Investors^[18]