A mountain guide can attempt to lead an expedition up a dangerous ascent but cannot force climbers to follow; that requires competence and trust. When the Federal Reserve begins to lower interest rates during a period of persistent inflationary pressure, it risks reviving a specter long thought consigned to the 1970s: stagflation. This toxic mix of stagnant growth, high unemployment, and elevated inflation is particularly dangerous because traditional monetary tools lose effectiveness—the very act of fighting one problem can worsen the other. Bond investors understand these things and are not following the Fed’s lead of an interest rate cut on Wednesday of this week, and are rather demanding more interest for the risk of holding U.S. Treasury debt. What gives?
Sticky Inflation Meets Monetary Easing
Inflation that proves “sticky” tends to come from services, wages, or supply-side constraints rather than one-time shocks like energy prices. These underlying pressures are less sensitive to changes in interest rates. If the Fed eases too early, cheaper credit can reignite demand without resolving supply bottlenecks. The result: inflation plateaus or re-accelerates, rather than falling back to target.
Growth at Risk
Rate cuts are typically intended to cushion slowing growth or avert recession. But if inflation expectations remain elevated, households and businesses may demand higher wages and prices to protect purchasing power. This undermines real growth, erodes consumer confidence, and can deter investment. Instead of stimulating activity, lower rates may trap the economy in a cycle of weak output and sticky price gains.
Lessons from History
The 1970s illustrate how premature monetary easing deepened stagflationary dynamics. Policymakers oscillated between fighting inflation and supporting growth, eroding credibility. It took years of painful tightening under Paul Volcker to reset expectations. Today, while the structure of the economy is different, credibility and expectations remain central. A Fed perceived as too willing to tolerate inflation risks losing its anchor, making policy less effective over time.
Navigating the Trade-Off
The Fed faces a delicate balancing act. Cutting rates too soon could entrench inflation above target, forcing sharper hikes later and increasing recession risk. Waiting too long, however, could exacerbate financial stress and unemployment. Clear communication, credible inflation targeting, and close monitoring of wage and service-price dynamics are essential to avoid repeating the mistakes of the past.
Bottom line: If the Fed eases policy in the face of sticky inflation, it risks trading a short-term growth boost for the longer-term pain of stagflation—a scenario far more damaging and difficult to escape.1
Following the 25-basis point cut in the fed funds rate on Wednesday, Treasury rates rose noticeably across the yield curve.2 These are market rates driven by bond investors, collectively known to be the best economists in the world. This contrary move indicates that bond investors are calling the Fed’s bluff and warning of the risk of stagflation. Stay nimble and may God bless your wealth-building efforts! Shaun
“For the LORD gives wisdom; from his mouth comes knowledge and understanding” ~Proverbs 2:6
1 ChatGPT, September 19, 2025, “The risk of stagflation if the Fed cuts rates while inflation remains sticky”
2 U.S. Department of the Treasury, September 19, 2025, “Daily Treasury Par Yield Curve Rates”
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