Traders bet on rate cuts as Fed fights inflation

The Federal Reserve slashed its balance sheet by $39 billion in August, bringing the total down to $6.60 trillion. That’s the lowest number since April 2020, back when COVID-19 lockdowns forced the Fed to go full bazooka.

Since hitting a peak in April 2022, the world’s most powerful central bank has cut a total of $2.36 trillion, shrinking its assets by 26.4%. But let’s not pretend they’ve hit reset, because that rollback only unwinds 49.2% of the $4.81 trillion it added during the pandemic.

As a slice of the U.S. economy, the Fed’s balance sheet now stands at 21.8% of GDP. That’s the smallest footprint since Q1 2020, putting it right back where it stood in 2013.

Still, don’t get it twisted. The Fed is holding on to $2.45 trillion more than it had before the pandemic. That’s 59% higher than pre-COVID levels. So anyone saying the stimulus is gone is either lying or doesn’t know how to read a spreadsheet.

Traders bet on rate cuts as Fed fights inflation

Bond traders are now piling into bets that the Federal Reserve will go on a rate-cutting spree starting this month. They’re pricing in a 0.25% cut at the September 16–17 meeting, and maybe two more by the end of the year.

Weak job numbers and calm producer prices have pushed them into this corner. But the real trigger is inflation. The consumer price index report coming Thursday is expected to show core inflation still sitting well above the Fed’s so-called target. That has Wall Street on edge.

Over the past month, yields on 2-year U.S. Treasuries fell to the lowest since April, showing how bullish traders have gotten. Maybe too bullish. If that CPI report runs hot, all those bets could flip upside down real fast.

For now, the markets think the Federal Reserve will go beyond neutral, meaning they’ll cut rates to a point where monetary policy stimulates the economy, not slows it down.

That shift is wild. Just a year ago, traders weren’t this confident. Inflation was sticky, and no one believed the Fed would slash rates this deeply. Now, it’s the default bet. The broader feeling is that Powell and his crew will have to slash fast to dodge a recession.

Trump slams Powell while Wall Street eyes Fed independence

President Donald Trump hasn’t kept quiet. He’s been hammering Fed Chair Jerome Powell for being too slow to cut rates, trying to steer the Federal Reserve from the sidelines.

“There’s also some of the political economy here… it seems obvious that a requirement for a job at the Fed now is that you are going to cut interest rates, and by a lot,” said Benson Durham, Piper Sandler’s global asset allocation head and former Fed insider.

Matthew Hornbach, the macro chief at Morgan Stanley, added that fears about the economy are growing fast. He said he believes investors will drive markets to price in a trough policy rate from the Fed well below the September 2024 nadir.” For context, that nadir was about 2.7%, traders now expect it to go even lower, according to data from Bloomberg.

Meanwhile, Wells Fargo CEO Charlie Scharf says he “absolutely” supports the Federal Reserve’s independence, even as Trump shouts from the rooftops.

Charlie told CNBC’s Squawk Box that Fed leaders have fixed terms that don’t match political cycles, so they should stick to their own decisions. But he admitted, “The administration is entitled to be vocal about it,” and “Trump happens to be very vocal.”

Meanwhile, markets expect the Fed to lower interest rates at its September 17 meeting, after recent inflation data came in lighter than expected and the labor market shows signs of trouble. CME FedWatch currently calculates a 90% chance the central bank will cut 25 basis points, and a 10% chance it’ll cut 50 basis points.

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