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As we anticipated earlier this month, the Fed didn’t cut rates. They did still forecast two cuts. The positioning allows both time for financial conditions to change – and for the Fed to react to them.

And they still eased monetary policy which we expected. How? By reducing the amount of U.S. Treasury bonds they let ‘roll’ off their books to $5 billion from $25 billion per month.

But the reality is that the Fed is sitting on a $6.7 trillion book of assets, of which $4.2 trillion is Treasuries. Realistically, $5 billion or $0 is pretty much the same thing. But optics called, and the Fed seemingly answered.

Based on today’s post-FOMC meeting results, we maintain our forecast that we could see 100 basis points of cuts coming this year. This will likely come from two or three rounds of cuts.

The obvious reason is the slowing U.S. economy. The hidden reason is – again – the banks.

They continue to amass losses. That has bank CEOs secretly worried.

As JPMorgan Chase CEO remarked last week, “Every CEO I talk to, we’re starting to talk about a more fearful economy right now.”

The Fed’s Balancing Act: Inflation, Jobs, and Wall Street
 

Officially, the Fed has a dual mandate: maximum employment and stable prices.

But there’s also the hidden third priority – Wall Street. And the lords of finance have been feeling unloved.

Now, the Fed’s walking a gauntlet. Inflation isn’t yet at 2% and probably won’t get there (and stay there) any time soon. So, after 100 basis points of cuts last year, the Fed wanted to slow the pace down.

But the economy is slowing. Markets are desperate for cheaper money. Wall Street needs an adrenalin shot. On top of that, the Fed doesn’t want to deal with a banking crisis.

While the Fed may be hoping to avoid financial turmoil, they do see the numbers.

Banks Are Sitting on Billions in Losses
 

According to the FDIC, unrealized losses on investment securities hit $620 billion in Q4 2024 – a $150 billion jump in just months. Banks loaded up on long-term bonds when rates were low. Now, those bonds are worth far less, locking them into deep losses.

Loan delinquencies are climbing, with 3.6% of outstanding debt now delinquent, according to the New York Fed’s latest Household Debt and Credit Report. That’s the highest level since 2020. The reading reflects growing financial strain on consumers and adding pressure on banks already facing with unrealized losses.

Banks will have to take these losses at some point. The easiest way to soften the blow? Rate cuts. Lower borrowing costs give them room to absorb the damage before things spiral further.

Even the Fed Is In the Red
 

The Fed itself is in trouble. Just like the banks, the central bank is holding long-term bonds that have lost value. Worse, because banks aren’t paying the Fed enough in interest, the central bank isn’t sending money to the U.S. Treasury like it usually does.

Now, to be clear, the Fed is not a business and won’t “go under.” But it does show us an indicator that things are not getting better, and in fact are trending in the opposite direction.

The Fed’s deferred asset – essentially its IOU to itself – has hit $223.8 billion. A year ago, that number was much smaller. While the Fed doesn’t “lose money” like a business, this highlights how financial strain is building system-wide.

A Flashback to the 2008 Financial Crisis – And SVB
 

In 2008, banks faced mounting subprime defaults all while downplaying the risks and financial ramifications and hoping they would go away. That didn’t last. Eventually, as most nefarious operations do, the numbers didn’t add up. They could no longer hide from economic realities, defaults and financial malfeasance. The Fed stepped in with bailouts, rate cuts and quantitative easing (QE) to boost the financial markets.

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The difference today is that instead of bad mortgage loans, banks are drowning in unrealized bond and commercial real estate loan losses.

The collapse of Silicon Valley Bank in 2023 was a warning shot – too many long-term securities, panic, and a rapid implosion. The question now is whether banks can hold on long enough for the Fed to step in.

That’s why the Fed is weighing its words. They need to cut rates to ease bank pressure, but they can’t make it look like a bailout. So, they keep talking about inflation while leaving the door open for cuts when needed.

By June, when the Fed’s so-called “stress test” results are out, we may get another key indicator of what to expect from some of the biggest banks on Wall Street. The question is, will things begin to break before then? Or will the Fed cut more than 50 basis points of cuts for 2025?

Bank CEOs Won’t Say “Cut Rates” – But They Don’t Have To
 

The last major bank CEO to openly push for rate cuts was Bank of America’s Brian Moynihan in August 2024. Since then, CEOs have been more subtle – dropping recession warnings into earnings calls, hoping the Fed gets the message.

Big banks love cheap money. Stock markets love cheap money. If they sound the alarm on slowing growth, they don’t have to ask for cuts – the Fed will feel the pressure anyway.

Historically, when the Fed has faced banking or other crises, it has responded aggressively. In 2008, they slashed rates from 5.25% to near zero in just over a year. During the COVID crisis, they cut from 1.75% to zero in weeks. If financial strain worsens, don’t expect a slow, measured approach – the Fed has a history of moving fast when the system is at risk.

Wall Street is already betting that the Fed will cave.

Hence why the market was euphoric despite no rate cuts.

According to the CME FedWatch tool, traders are pricing in at least two to three rate cuts this year. Investors are over the "wait to see how inflation evolves” thing, there are too many other uncertainties pelting the financial system.

What This Means for You
 

Expect more market chaos until the Fed coughs up a 50-basis point rate cut. A faster pace of cuts would likely send stocks soaring. Markets love cheap money, and lower rates make equities more attractive compared to bonds.

For consumers, lower rates should bring cheaper mortgages, car loans, and credit cards. But that hasn’t happened yet, since banks are hoarding money in case of more downside to their loans.

Because here’s what the Fed won’t admit, bank loan losses are mounting.

So, once again, the Fed continued its talk tough on inflation. And the Fed loosened QT policy as a precursor to more rate cuts.

Wall Street, watching trade wars, tariffs, and volatility, is clinging to cuts as its best hope. If growth slows and bank problems escalate expect rate cuts to come faster, or QE to make a comeback.

That’s what the Fed’s still not telling you.

In the meantime, hedging beyond the U.S. markets and with assets like gold that can handle all this stress could offer a great alternative to the storm clouds building from the U.S. financial sector.

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