The Federal Reserve is about to make one of its biggest calls of the year on Wednesday.
This week’s interest rate decision is the event that markets are glued to.
With a 96% chance of a rate cut priced in, the outcome looks almost certain. What is not certain is the context.
Inflation remains sticky, political pressure is rising, and gold is trading not only as a hedge against price increases but also as a hedge against credibility.
Going into the decision, three themes stand out that investors should keep at the forefront.
Is the Fed going to cut while inflation is still high?
Markets are confident the Fed will trim its policy rate by 25 basis points this week.
The effective rate has stood at 4.25 to 4.50 percent for a while. A small step lower looks likely after a series of weak economic indicators.
Unemployment stands at 4.3%, the highest rate since late 2021.
The Department of Labor revised job growth down by 911,000 for the April 2024 to March 2025 period.
Weekly jobless claims rose to 263,000 in early September, a sharp jump from the summer average.
Source: Bloomberg
Meanwhile, inflation is not fully under control. Consumer prices rose 2.9% in August from a year earlier.
Core inflation, which excludes food and energy, stood at 3.1%. The Fed’s preferred gauge, the core PCE index, is tracking close to 2.9%.
Although these are not crisis numbers, they are still above the Fed’s targets.
Cutting now means accepting inflation will not reach the Fed’s preferred levels.
Ultimately, the Fed’s language will matter as much as the action. Chair Jerome Powell will argue the move is insurance for a softening labour market.
Investors should recognise that the Fed is not waiting for inflation to return to target before easing.
It is betting that labour risks outweigh the danger of entrenching a new inflation floor.
Can monetary policy offset tariffs?
This is where the policy mismatch emerges. Much of the price pressure is not coming from excess demand, but from tariffs.
The current trade regime has raised costs across imported goods.
Research estimates suggest new tariffs could add 1.7% to the overall price level in the short run.
Manufacturing and wholesale trade have seen the largest recent job losses.
A lower policy rate does not make imported parts cheaper or offset tariff surcharges.
For these sectors, rate cuts are largely irrelevant. Yet this is where the political pressure is strongest.
The result is a central bank using monetary easing to respond to a fiscal and trade shock it cannot fix.
What this all means is that lower rates may support credit and lift equity valuations, but they will not reverse tariff-driven inflation.
That combination risks creating a cycle where asset prices rise while real-economy costs remain elevated.
The last time this happened, in the 1970s, gold surged more than 2,000%.
Independence is becoming a market variable
The Fed’s credibility is not only about inflation expectations anymore. It is now about political independence.
The risk is that investors interpret any cut as yielding to pressure from the White House.
The market may no longer see forward guidance as credible, but as conditional on political events.
That perception changes risk pricing. Term premia can rise even as the policy rate falls.
FX volatility can increase if investors think the dollar’s path depends on political cycles rather than economic data.
This is why the Fed’s decision this week is more than a technical adjustment. It is a signal about the institution itself.
The surge in liquidity demand also underscores the fragility. Banks are borrowing at a record pace through the Fed’s Standing Repo Facility in recent months.
This shows how tight conditions can appear suddenly. Investors should expect more of these short bursts. They will not sink the system, but they are reminders that the plumbing is sensitive to credibility.
Gold as a credibility hedge
Gold has hit record levels this year, but the drivers are different from the past.
It is not only a hedge against inflation. It is also becoming a hedge against institutional credibility.
Central banks have been net buyers for three consecutive years, adding more than 1,000 tons annually.
At current prices, this goes beyond speculation. It is diversification away from the dollar as trust erodes.
For investors, this means gold should not be treated as a bubble. In the 1980s and 1990s, gold collapsed because inflation fell and dollar credibility rose.
Today, even with inflation moderating, official sector buying continues.
That makes gold less cyclical and more structural. It is protection not only against higher prices, but against political influence over monetary policy.
This also changes how portfolios should be built. Gold exposure through ETFs or physical allocation makes more sense than chasing high-beta mining stocks.
The latter depend on input costs and corporate governance. The former reflects the credibility hedge itself.
The new equilibrium: a 3 percent world
Perhaps the most important insight is that policy easing with core inflation near 3% risks entrenching that level as the new equilibrium.
The neutral real rate may have shifted higher due to deglobalization and higher fiscal deficits.
If so, the Fed’s cuts may not be deeply stimulative, but still enough to leave inflation stuck above target.
This is the danger for investors who assume a swift return to a 2% world. The risk is that markets adjust to a 3% world instead.
In that environment, equities may remain supported by liquidity, but real incomes remain pressured.
Bonds offer less protection. And gold, as both an inflation hedge and a credibility hedge, stays in demand.
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