Fed's 25bp Cut Won’t Save This Economy

The “Bad News Is Good News” trade is a faith-based rally. Here’s what breaks when the market realizes rate cuts are not stimulus, they’re a diagnosis.

For professional investors & macro traders. This is research, not investment advice.

Input Variables (Data / Events)

1) Policy is already in “easing mode,” but conditions are not behaving like a normal easing cycle.

• The Fed’s target range is 3.50%–3.75% after the Dec 10, 2025 cut.  
• The upper limit of the target range is 3.75% as of Dec 21, 2025.  

2) Markets keep treating “cut” as “rocket fuel.”

• Traders were pricing ~87% odds of a 25bp cut into the Dec meeting (pre-decision).  
• Post-cut, equities still rallied on hopes of more easing even as the Fed signaled caution.  
• The “bad news is good news” framing has been explicitly called out in market commentary this year.  

3) The inflation data is “cooling,” but the reliability is questionable (and that matters).

• November CPI printed 2.7% YoY (and core 2.6%) but multiple analysts flagged distortions tied to the shutdown and data collection timing.  
• Cleveland Fed’s Beth Hammack has openly questioned whether the November CPI understates inflation, preferring to hold rates steady into spring.  

4) Labor is weakening, but not collapsing. That “in-between” is where fake optimism thrives.

• The U.S. added 64k jobs in November, unemployment 4.6% (highest since 2021 per AP), with shutdown distortions all over the tape.  

5) Credit is not screaming recession yet. That’s the trap.

• U.S. high-yield OAS is around ~2.95% (Dec 18, 2025), i.e., still tight by historical standards.  

6) Growth nowcasts are not “disaster.” That creates narrative leverage.

• Atlanta Fed GDPNow had 3.5% (SAAR) as of Dec 16, 2025 (for Q3 tracking), with the next update set for Dec 23.  

Structure Explanation (Mechanism)

1) The market is confusing 

rate cuts

 with 

easing conditions

A 25bp cut is a price change of the short rate. It is not automatically a regime change for financial conditions.

Why that matters:

• If inflation is sticky (or suspected sticky), the Fed can cut once or twice and then… stop. That’s not a “cycle,” it’s a calibration. Hammack’s “hold steady for months” message is basically that in plain English.  
• When the market prices a long runway of cuts but the Fed delivers one-and-done (or cut-and-pause), risk assets can gap down because the expected future path was doing most of the valuation work.

2) “Bad news is good news” works only while the economy is still fundamentally okay

This is the psychological engine of the rally:

• Weak jobs / softer CPI → “Fed will cut” → lower discount rate → higher multiples → stocks up.
  But the trade flips when the market realizes:
• Weak jobs / weaker demand → earnings risk → credit risk → equities down.

That’s the pivot point. Humans call it a “narrative shift.” Macro traders call it “you’re long the wrong duration.”

Reuters has basically described this reflex: markets trying to see the bright side of bad news because they crave cuts. 

3) A 25bp cut is not a rescue package. It’s a diagnosis.

If the economy needs more than 25bp, that implies something uglier:

• either growth is rolling over faster than expected,
• or credit is tightening,
• or something breaks in the plumbing (funding markets, banks, CRE, etc.),
• or the Fed is trying to “get ahead” of stress.

In other words: if markets realize “25bp isn’t enough,” the conclusion is not “bullish, more cuts coming.” The conclusion is “bullish-for-bonds, bearish-for-risk.”

4) The “fake optimism” setup in late 2025 is unusually toxic

Because the data itself is noisy:

• Shutdown distortions hit CPI and labor prints, and even policymakers are telling you the tape is messy. 
  That raises the probability of mispricing. And mispricing creates violent repricing.

5) Why credit spreads being tight is 

not

 comforting right now

HY OAS near ~3% is the market saying “default risk is low.” 

But tight spreads late-cycle often mean one of two things:

• either fundamentals are truly improving,
• or investors are reaching (starved for yield, assuming liquidity will stay abundant).

If the “cut = liquidity forever” belief breaks, spreads can reprice quickly, and equities will not enjoy that.

The Core Scenario: “25bp Isn’t Enough” becomes a bearish realization

Here’s the specific sequence you asked for:

Phase A: The market’s current belief

1. Inflation is “coming down.”
2. The Fed is cutting.
3. Therefore the Fed is supportive.
4. Therefore dips are buyable.
5. Therefore “bad news is good news.”

Phase B: The moment the mask slips

The market realizes:

• If the economy truly needs meaningful relief, 25bp is cosmetic.
• If more cuts are required soon, that means demand and earnings are deteriorating, not “soft landing victory.”

That’s where rallies turn into air pockets.

Phase C: The repricing channel

• Rates: bull steepening (front-end yields fall faster), but watch term premium.
• Equities: multiples compress because earnings risk dominates discount rate.
• Credit: spreads widen, “quality” outperforms, refinancing risk gets repriced.
• USD: ambiguous (risk-off supports USD, but aggressive Fed easing can weaken it).
• Vol: goes from “annoying” to “structural.”

Triggers (What makes the market “find out”)

You don’t need a grand apocalypse. You need one of these:

Trigger 1: A “pause” message hardens into policy

• Hammack-style messaging (hold into spring) becomes consensus: one cut, then a long wait. 
  Market has to remove the “continuous easing” fantasy.

Trigger 2: Inflation re-accelerates or stays sticky, 

and

 growth softens

That’s the nightmare combo: stagflation-lite.

Reuters flagged economists warning inflation could accelerate in December. 

Trigger 3: Labor weakens further, but the Fed can’t respond aggressively

Unemployment at 4.6% is already higher than the market was comfortable with. 

If it rises while inflation credibility is shaky, the Fed’s reaction function tightens.

Trigger 4: Credit spreads start widening from “too tight”

HY OAS around 2.95% is not pricing stress. 

If that pushes up meaningfully, it becomes self-fulfilling tightening.

Trigger 5: Equities continue levitating while the macro story fractures

Rallies after the cut, despite the Fed’s caution, are exactly the kind of “faith rally” that breaks violently when liquidity expectations disappoint. 

Trade Path (Macro Trader Playbook)

1) Base view: Fade “perma-positive” pricing, not the whole world

You want to short the narrative, not necessarily short GDP.

Expression ideas (conceptual, not instructions):

• Long quality duration (UST belly / front-end sensitive expressions) vs short equity beta.
• Long rates vol when implied is cheap relative to macro uncertainty.
• Equity hedges focused on crowded optimism: indexes, growth-heavy baskets, or “everything-up” exposures.
• Credit hedges (CDX HY / LQD vs HYG relative thinking) if spreads are mispriced.

2) Scenario split (because you’re not running a feelings-based fund)

• If Fed pauses + inflation sticky: risk assets re-rate lower, curve may bear-steepen if term premium rises.
• If Fed cuts more because growth cracks: risk-off dominates, curve bull-steepens, credit underperforms, equities drawdown.
• If inflation collapses cleanly and growth holds: then the market was right, and you don’t fight it, you ride it.

3) Timing filter: watch the “data credibility” window

Shutdown distortions mean the next clean prints matter more than usual. 

When the tape is unreliable, positioning becomes more fragile.

Risk Failure Point (Invalidation)

This thesis fails if all three happen:

1. Inflation cools in a clean, believable way (no “data glitch” asterisks),
2. Labor stabilizes without further deterioration,
3. The Fed can cut gradually without credit widening.

In that world, 25bp is enough because it’s just fine-tuning a soft landing.

Also: if HY spreads stay pinned near ~3% while earnings hold up, your “stress repricing” catalyst is missing. 

Action Priority (Do / Don’t)

Do

• Treat “rate cut = bullish” as a conditional statement, not a law of nature.
• Track the cut narrative versus the Fed’s stated intent (cut-and-pause risk is real).  
• Watch credit spreads like a hawk because equities can ignore macro until credit forces them to stop.  
• Respect data quality: distorted CPI/labor prints can cause false breakouts and trap positioning.  

Don’t

• Don’t anchor to “25bp = stimulus.” It’s not.
• Don’t assume “more cuts” is automatically bullish. If you need more cuts, something is breaking.
• Don’t ignore the possibility that inflation is under-measured right now (even Fed officials are airing that concern).  

The punchline (what most people miss on purpose)

A small cut is only “good news” if the economy is fundamentally okay.

If the economy is not okay, then a small cut is the exact opposite: it’s proof the market is partying inside a building that already smells like smoke.

And if investors collectively “find out” that 25bp isn’t enough, the next thought is not “stocks up.”

It’s: “Then we’re late.”