The Fed Meets the Monster of Its Own Making

The Federal Reserve is about to cut rates next Wednesday. Markets have priced it in at 89%. The only question left is whether Jerome Powell will emerge from the meeting looking like a surgeon or a firefighter—measured and deliberate, or panicked and reactive. The data makes it impossible to tell which one he'll be.

This is what the central bank hath wrought: A labor market that whispers in contradictions. A system so finely calibrated that it can no longer distinguish between healing and hemorrhaging.

The Mathematics of Collapse

ADP's private payroll numbers arrived Wednesday morning like a slap: 32,000 fewer jobs in November than expected. The survey predicted growth. Instead, America shed workers, most of them from small firms. This is the harbinger data always was. When companies with fewer than 20 employees start cutting, the nervous system of the economy is signaling distress before the organs fail.

But here's where the madness begins. The market's reaction to worse-than-expected jobs data wasn't fear. It was relief. Thanksgiving relief. The kind you feel when a diagnosis confirms your intuition, and suddenly you know what to do about it.

An economy deteriorating fast enough to justify a rate cut. That's the bargain we've struck. That's what joy looks like now.

The unemployment rate sits at approximately 4%. Initial jobless claims just hit a three-year low at 191,000. Core PCE inflation—the Fed's preferred measure—came in at 2.8%, below expectations. Consumer sentiment improved in early December. Year-ahead inflation expectations fell to 4.1% from 4.5% a month prior. Long-term inflation expectations dropped to 3.2%.

On paper, this looks like soft landing weather. A plane descending smoothly, passengers unfastening seatbelts, crew preparing the cabin. But the altimeter is contradicting the instruments. Somewhere between the surveys and the sentiment, between the numbers and the narrative, a fault line has opened.

How We Got Here

Twenty-one months ago, inflation was eating the American economy like acid. The Fed responded by hiking rates faster than anyone had done in a generation—pushing the target rate to 5.50% in July 2023. They kept it there because the labor market wouldn't break. Unemployment stayed low. Wages kept rising. Companies kept hiring. Powell and his colleagues decided the economy was tougher than it looked.

So they waited. They watched. They signaled patience. And the market, believing it had read the Fed's mind, priced in no cuts until sometime in 2025.

What happened next was the great unraveling of confidence. Not in the economy exactly—the economy was fine. What broke was the psychological pact between the Fed and the market. The central bank had spent years warning that inflation was "transitory," only to watch it stick. They'd insisted the labor market was "resilient," only to watch the data deteriorate beneath the surface while the headline numbers held steady.

By autumn, markets were nearly certain a cut was coming. By early December, they're betting their house on it.

The Trap

Here's the thing the Fed understands but can't say out loud: They may not actually know whether the economy needs a rate cut or not. The data is genuinely contradictory. Hiring is slowing, but unemployment isn't rising. Consumer spending is expanding, but consumers are drowning in debt and turning to buy-now-pay-later services like they're oxygen masks during a crash landing. Three-year low jobless claims suggest the labor market is resilient. Private payroll declines suggest it's cracking. Both can be true. Both probably are.

The Fed faces a choice between two types of error.

Cut rates and you risk reinvigorating inflation at the moment it's finally—finally—starting to ease. Let that happen, and you've undermined the entire apparatus of your credibility for the next decade.

Hold rates steady and you watch the labor market deteriorate further. The psychological toll alone—knowing you could have prevented it—becomes unbearable. Markets crater. Politicians howl. The Fed chairman becomes the villain in a story where he's already the scapegoat.

So Powell will cut. Not because the data demands it. Because the Fed has maneuvered itself into a position where cutting is the only move that doesn't end in institutional humiliation.

The Dollar's Long Goodbye

While the Fed wrestles with its demons, the dollar is collapsing with remarkable courtesy. It's on pace for its seventh consecutive day of declines—its longest stretch of weakness since July 2020. Deutsche Bank economists now forecast 10% additional dollar weakness by the end of 2026. The bull cycle that defined the 2020s is ending.

This is what happens when the world's central bank starts easing while most other central banks hold. Capital doesn't flee the dollar because it hates America. It flees because there are better yields elsewhere. It's arithmetic dressed in currency flows.

Bitcoin, meanwhile, bounced above $93,000 this week—a two-week high—before retreating. The cryptocurrency is trying to reclaim the narrative: a hard asset, immune to central bank manipulation, ready to thrive in a lower-rate environment. Asset managers are watching. If the dollar truly weakens 10% in the next year, and if rate cuts really do begin a new risk-on cycle, the argument for owning bitcoin becomes less fringe and more obvious.

The Earnings Theater

Interspersed in this macro drama are the usual earnings performances. Retail is having a moment—Ulta Beauty surged 6%, Victoria's Secret climbed 13% premarket on raising guidance, American Eagle jumped 13%. Discount retailers are winning. Dollar General raised guidance; Five Below's earnings tripled expectations. The subtext: consumers are adapting. They're trading down. They're bargain hunting. This isn't the behavior of an economy bursting with confidence. It's the behavior of an economy planning for stress.

Meanwhile, Microsoft fell 2.5% Wednesday when reports surfaced that it was cutting AI sales quotas. The company denied it, recovered somewhat, but the wound was made. For months, the AI trade has been the foundation of the market's bull case—the one story that could justify valuations, that promised future productivity, that transformed speculation into strategy.

If Microsoft is quietly lowering AI targets, what does that mean? It could mean quotas were unrealistic. It could mean demand is softening. It could mean Big Tech finally agrees with the pundits who've whispered for months: We're funding our own revenue growth. We're betting on a future that may not arrive.

Former Intel CEO Pat Gelsinger made it explicit this week. The AI boom fueling markets, he said, might be illusory. Tech giants are committing capital to their own future revenue because there's no other game in town. "I'm buying my own future revenue," he said, with the matter-of-factness of a man who's seen this before.

What Comes Next

Powell will cut rates Wednesday. Markets will likely rally—relief cuts usually do. The dollar will weaken. Yield-sensitive stocks will bid up. Tech will stabilize. The narrative will shift from "the Fed is choosing between bad options" to "the Fed has chosen the right path."

For about forty-eight hours, it will feel like clarity.

Then the real work begins. A Fed chairman with a damaged reputation for data-dependence (because he's about to cut when the data says "maybe don't"). A labor market that's neither healthy nor broken, but something in between that has no name yet. A consumer who's borrowed money against Christmas that they'll have to pay back in January. A dollar that's deflating. An economy that's doing fine on paper but feeling fragile in practice.

The Fed didn't create this situation alone. It inherited inflation and chose to fight it with blunt force. But it did choose, and choices have consequences. You can't spend months explaining that the labor market is resilient and then treat it like it's fragile the moment the data shifts. You can't claim your primary mandate is price stability and then pivot to full easing when inflation is merely "moderating" rather than "solved."

What Powell is about to do—cut rates into a labor market that remains close to full employment while inflation is still 1 percentage point above target—is not a mistake. It might be necessary. It might even be wise.

But it is the Fed confessing that it has less control over the economy than it claims. That it moves not by economic law but by political psychology. That in the final analysis, a central bank cannot engineer outcomes so much as manage narratives around outcomes it doesn't fully understand.

On Wednesday, it will be Powell's turn to manage the narrative. We'll find out if anyone is still buying.