Federal Reserve rate cuts could create more harm than good

With great anticipation, the Federal Reserve cut interest rates by 0.50% on Sept. 18.

That first rate cut since the COVID-19 pandemic marked a turning point in the war against inflation, which dominated financial news and dictated market movements for 2½ years.

The Fed implemented additional cuts of 0.25% each in November and December, decreasing the Fed Funds Rate by 1% in total through the past four months.

During the same time, most bond yields have gone up by a lot. The 10-year U.S. Treasury yield has increased from 3.65% in mid-September to 4.8% this week, its highest level since April 2024.

There are plenty of explanations for why bond yields would increase while the Fed is actively pushing interest rates lower. Among them:

All three suggestions end the same way. Financial markets are still concerned about inflation. The Fed does indeed influence short-term interest rates, which are falling, but longer-term bonds like the 10-year Treasury are a better reflection of inflation expectations.

Recent data supports these concerns. The Consumer Price Index (CPI), the most-often cited gauge of annual inflation, fell below 3% in July and went as low as 2.4% in September. Since then, inflation has risen in three-consecutive months, with the latest report revealing a 2.9% increase from a year earlier.

It’s unclear whether inflation will continue rising, but we won’t fault investors for experiencing some PTSD. We all saw how destructive inflation could be to asset prices in 2022, when CPI peaked at 9.1% and the S&P 500 fell nearly 20%.

The bullet points we mentioned do all contribute to inflation. But there is another less popular explanation for this latest move higher: Maybe the Federal Reserve is getting its monetary policy wrong and should not be cutting interest rates.

Should that really be so hard to believe? Fed Chair Jerome Powell, who quarterbacks our central bank, filled the same role three to four years ago when the Fed made what we now accept as an obvious mistake. The Fed in 2021 kept its benchmark interest rate near zero despite soaring economic growth (U.S. GDP +5.8%). It wasn’t until March 2022 that the Fed began hiking. By then, annual inflation was approaching 8%, and the Fed was chasing an animal it had helped unleash.

Recency bias makes it easy to credit Powell and the Fed for sticking the proverbial “soft landing,” meaning they corralled inflation without triggering a recession. But that victory might not last if policy becomes too dovish too quickly.

It’s not a coincidence bond yields hit an 18-month low two days before the September Fed cut and have been rising ever since. Investors are conditioned to think lower interest rates are better, but the bond market is reminding us stimulus comes with side effects.

The Fed, at least, has taken notice and adjusted its 2025 guidance to reflect fewer rate cuts in the year ahead. As a result, meaningfully lower mortgage rates and the death of inflation narratives (like this one) will take longer to achieve.

In the big picture, those sacrifices will seem small if it means Powell and his Fed governors have learned their lesson. Perhaps there will be fewer policy mistakes this time. Perhaps the recent inflation bump will prove transitory.

The market, however, is not yet convinced.

Ben Marks is chief investment officer at Marks Group Wealth Management in Minnetonka. He can be reached at ben.marks@marksgroup.com. Brett Angel is a senior wealth adviser at the firm.