Markets are sure the Fed will cut in September, but the path from there is much murkier

Following Federal Reserve Chair Powell's dovish Jackson Hole remarks, markets initially rallied on expectations of interest rate cuts, with CME FedWatch indicating an 82% probability for a September reduction. However, caution emerged as investors and analysts, including BNY and Morgan Stanley, expressed skepticism regarding the necessity and pace of further easing, citing persistent inflation concerns, a resilient economy, and potential for unintended market reactions similar to 2024 where bond yields rose despite cuts. This divergence highlights significant uncertainty over the Fed's future policy trajectory and its broader impact on market dynamics and economic stability.

Analysis

The market is currently navigating a significant disconnect between near-term rate cut expectations and underlying policy uncertainty following Fed Chair Powell's Jackson Hole address. While futures markets, tracked by CME Group's FedWatch, are pricing in an 82% probability of a quarter-point rate reduction on September 17, prominent institutional voices express considerable skepticism. Jason Granet of BNY characterized the Fed's stance as having the door merely "ajar" for a cut, emphasizing that the future pace of easing remains a central question dependent on incoming data. This caution is amplified by Morgan Stanley's Lisa Shalett, who questions the fundamental need for easing, given a resilient economy and tariff-related inflation risks, assigning only a 50% probability to a September move. A key risk highlighted is a potential repeat of the 2024 scenario, where Fed cuts inadvertently triggered a 100-basis-point surge in bond yields, a concern voiced by Ed Yardeni. Despite this policy risk, Yardeni maintains a bullish outlook on equities, forecasting an earnings-led rally that could push the S&P 500 to 6,600 by year-end and 7,500 in 2026, suggesting his targets may be conservative if the Fed proceeds with cuts.

Key Decisions for Investors

• Given the highlighted risk of a 2024 repeat where Fed cuts led to higher bond yields, investors should be cautious about extending duration in fixed-income portfolios and closely monitor the yield curve's reaction following the September FOMC decision.
• While a rate cut may provide a near-term catalyst, the bull case for equities is increasingly framed around earnings growth, suggesting investors should prioritize fundamentally strong companies over purely rate-sensitive assets.
• The wide divergence between market pricing for a September cut and skepticism from analysts like Morgan Stanley creates potential for significant market volatility, making it prudent to review and potentially implement portfolio hedges against a hawkish surprise from the Fed.
• Investors should closely monitor upcoming labor market and inflation data, as these figures will be critical in shaping the Fed's decision and the ultimate pace of any easing cycle.