Fed Rate Cut in May Would Be a Grave Mistake, Warns Larry Summers: Here’s Why Investors Should Heed the Warning
2min read The Federal Reserve faces a pivotal decision this month as it weighs whether to cut interest rates for the first time since 2024. But according to former Treasury Secretary Larry Summers, doing so would be a “very serious error” with lasting consequences. In a sharp critique of the central bank’s trajectory, Summers has argued that the Fed risks misreading the economic landscape by prioritizing job market concerns over persistent inflationary pressures—a misstep that could prolong stagflation and destabilize markets.
The Stagflationary Dilemma
Summers’ warnings center on the Fed’s “stagflationary shock”—a rare confluence of inflation near 2% (but under upward pressure from tariffs) and weakening job markets. While core inflation has moderated to 2.6% year-over-year, tariffs on imports—particularly from Mexico, Canada, and China—are reigniting cost pressures. The Fed’s own March projections now see inflation averaging 2.8% in 2025, delayed by 18 months compared to earlier expectations.
At the same time, unemployment is projected to rise to 4.4% by year-end, complicating the Fed’s balancing act. “You can’t figure out if you go to the brakes because of price increases or the accelerator because of lost jobs,” Summers said in an X thread, arguing that policymakers lack clarity to justify easing.
The Tariff Wild Card
Summers attributes much of the Fed’s dilemma to protectionist policies. “This is what tariffs do,” he said, noting how import taxes have distorted supply chains and pushed up consumer prices. The Fed’s March Summary of Economic Projections (SEP) now assumes a 5-percentage-point average tariff increase, which alone could shave 0.3% off 2025 GDP growth. Worse, retaliatory tariffs from trading partners—already hitting U.S. exports—could amplify the drag.
Investors should pay close attention to the Fed’s ability to disentangle “tariff inflation” from broader trends. If core inflation holds above 2.8%, the Fed’s credibility as an inflation-targeter weakens, leaving markets exposed to volatility.
Fed Watchers Split, Markets Nervous
The market’s view is split but leans toward a cut. CME Group’s FedWatch tool gives a 60% probability of a rate cut by July 2025, rising to 90% by September. Yet Summers argues such expectations ignore the risks of policy misalignment. “Markets can’t dictate Fed policy,” he emphasized, pointing to bond-market pricing as a misleading signal.
The Fed’s own internal scenarios highlight the uncertainty. In its downside scenario—where tariffs rise by 10 percentage points—the Fed would delay cuts entirely until 2026. Conversely, if trade tensions ease, two cuts this year remain feasible.
Implications for Investors
The stakes are high for portfolios:
1. Equities: A premature rate cut could boost cyclicals (e.g., industrials, financials) but risk a sell-off if inflation resurges.
2. Bonds: The 10-year Treasury yield has fallen to 3.4% on rate-cut bets—a move that could reverse if the Fed surprises markets by holding rates.
3. Tariff-Sensitive Sectors: Automakers (e.g., Ford, GM) and consumer discretionary firms (e.g., Walmart) face margin pressure from higher input costs.
Conclusion: Caution Pays
Summers’ warnings are backed by data. The Fed’s 2025 GDP growth forecast of 1.7%—down from 2.1% in December—reflects the toll of tariffs and policy uncertainty. With unemployment projected to rise and inflation still above target, cutting rates now risks rewarding bad policy while failing to address structural imbalances.
Investors should prepare for volatility. If the Fed holds rates as Summers urges, markets may reprice expectations, favoring defensive sectors (e.g., utilities, healthcare) and short-term Treasuries. A rate cut, however, could spark a rally—but one vulnerable to a stagflation-driven correction.
The Fed’s May decision isn’t just about rates; it’s about credibility. As Summers put it, “You can’t fix a policy error with another policy error.” Markets would be wise to heed that lesson.
