Tariffs Trigger Turmoil: Will the Fed Slash Rates 0.5% to Stave Off Economic Slide?

Wall Street is increasingly convinced that the U.S. Federal Reserve will cut interest rates in its upcoming meeting, with expectations of a 0.25% reduction now firmly embedded in market sentiment. However, speculation remains strong that Chairman Jerome Powell could surprise investors with a more aggressive 0.5% cut, especially in light of recent weak labor market data. Futures markets reflect this shift in sentiment, with S&P 500 futures rising 0.25% following the release of discouraging employment figures.

The nonfarm payroll report highlighted just 22,000 new jobs, with even weaker performance in the private sector. Torsten Sløk of Apollo Global Management noted that job growth turned negative in sectors most affected by President Trump’s trade tariffs. Daiwa Capital Markets confirmed this downturn, citing an average private-sector job gain of only 29,000 per month from June to August—far below the 100,000 average in Q1. Moreover, the private-sector payroll diffusion index, which tracks hiring trends across 258 industries, fell to 48 in August—well below the 50 threshold that indicates net hiring.

Despite this, some economists remain cautious, pointing to upcoming inflation data as a potential constraint on the size of the Fed's rate cut. The Bureau of Labor Statistics is set to release the Consumer Price Index (CPI) and Producer Price Index (PPI) data, with forecasters expecting both to show rising inflation, including a 2.9% annual rise in CPI—the highest since January. This trend has been attributed in part to Trump’s import tariffs, which have pushed up prices as businesses pass on costs to consumers. Brett Ryan of Deutsche Bank highlighted the growing impact of tariffs on core goods inflation, which excludes food and energy and typically serves as a more stable indicator of inflationary pressures.

Analysts are divided on the frequency and magnitude of the Fed's response. Convera’s George Vessey noted that the key debate is no longer whether the Fed will ease but how quickly it will act. Pantheon Macroeconomics forecasts three 0.25% cuts this year, while Wedbush’s Seth Basham expects only two. Jim Reid’s team at Deutsche Bank emphasized that while a 0.25% cut is fully priced in, a larger move would depend on unexpectedly weak inflation data.

Global markets have already reacted to the expectation of monetary easing. S&P 500 futures were up 0.25%, with European and Asian indices also posting gains, including a 1.45% rise in Japan’s Nikkei 225 and a 0.45% increase in South Korea’s KOSPI. While equity markets remain optimistic, fixed income and gold markets suggest investors are also bracing for potential inflationary surprises, particularly as the Fed grapples with its dual mandate of controlling inflation and supporting full employment.