Fed should avoid large interest rate cut

“There are many signs that the Federal Reserve (Fed) will implement the first interest rate cut in 2025 when it announces its interest rate decision on September 17, 2025, but there is uncertainty about the size of the cut. Market participants expect the policy rate to be lowered by 25 basis points to a range of 4.00–4.25 percent. Such an interest rate cut can be justified by the Fed's dual mandate and the slowdown in employment. However, a large interest rate cut of 50 basis points would be the wrong signal given that inflation is still persistently above 2 percent, and especially since there is a high risk that US companies will increasingly pass on higher production costs due to tariffs. This would further drive up inflation.

However, a large interest rate cut has been demanded for months by the Trump administration, which is increasingly questioning the independence of the central bank. President Trump's move to dismiss Fed Governor Lisa Cook before the interest rate decision is a direct attempt to influence the monetary policy of the independent Fed. With the election of loyal economist Stephen Miran as Fed Governor just ahead of the interest rate decision, the likelihood of enough votes coming together for a large interest rate cut increases.

This would send a fatal signal to capital markets and could be interpreted as a loss of political independence for the Fed and the beginning of a monetary policy aimed at keeping the interest costs of government debt as low as possible. The problem here is that once trust is lost in the central bank’s ability to guard price stability, it is difficult to regain. The result could be capital market turmoil, as was already the case in April 2025, when bond markets reacted to tariff announcements and attacks on the Fed's independence with sales of US government bonds. This led to significant spikes in yields on US government bonds and a devaluation of the US dollar.

To prevent capital market turmoil, the Fed should avoid a large interest rate cut and clearly communicate its independence and commitment to its mandate. Regarding further interest rate moves, it should clearly communicate that these decisions will remain strictly data-dependent and that neither premature easing nor political influence will determine the course.”