What does it mean for the market if Powell backs down and the Federal Reserve cuts interest rates early?

When will the Federal Reserve cut interest rates is becoming the market focus.

Recently, Goldman Sachs analyst Vickie Chang released a research report that analyzes four scenarios in which the Federal Reserve may implement monetary easing policies ahead of schedule and their cross-asset impacts. The report shows that regardless of the scenario, the decline in U.S. Treasury yields and the weakening of the dollar will be the main trends.

Since the end of April, market expectations for economic growth have improved, and bets on the Federal Reserve's easing policies have also increased. Although strong employment data and high inflation in the summer may challenge the market's pricing for interest rate cuts, if inflation data continues to improve in the next month or two, the market may further bet on earlier and deeper rate cuts.

This shift has recently become evident, with the market beginning to price in the Federal Reserve's easing policies more clearly. Goldman Sachs analyst Vickie Chang pointed out that the enhanced expectations for rate cuts may stem from improved inflation or increased confidence in the Federal Reserve's view that the impact of tariffs is "temporary," and its impact on asset prices will depend on the backdrop of economic growth.

Analysts noted that in all scenarios, the decline in yields, weakening of the dollar, and rise in gold prices are consistent, while the direction of the stock market highly depends on the assessment of economic growth prospects.

Scenario 1: Downward Inflation Risk Drives Rate Cuts

In this scenario, it is assumed that inflation data continues to exceed expectations, or the Federal Reserve is convinced that the impact of tariffs is temporary, leading the market to lower the 2-year U.S. Treasury yield by 25 basis points.

In terms of market response, the stock market rises, bond yields decline, the yield curve steepens, and the dollar weakens across the board.

From a volatility-adjusted performance perspective, the rise in the S&P 500 index and the decline in U.S. Treasury yields are the most significant.

Scenario 2: Declining Growth Expectations Drive Rate Cuts

If U.S. economic growth expectations are lowered by 50 basis points, the expectations for rate cuts will be entirely driven by weak growth.

This situation may occur due to further deterioration in labor market and economic activity data, especially when the market finds it hard to believe that tariffs have limited damage to the economy.

In this scenario, both the stock market and bond yields decline, the yield curve steepens, and the dollar slightly weakens overall, but the weakness is most evident against reserve and safe-haven currencies.

After adjusting for volatility, the largest directional changes are a decline in the S&P 500 index, an increase in the VIX index, and a decline in U.S. Treasury yields.

Scenario 3: Dovish Policy + Downgraded Growth Expectations

This scenario combines the impact of dovish policies and negative growth shocks, with the market pricing in both Federal Reserve easing and downgraded growth expectations.

The U.S. stock market declines slightly, bond yields fall more than in the previous two scenarios, the yield curve steepens, and the dollar weakens across the board. From a volatility-adjusted perspective, the decline in yields is the most significant change.

Scenario 4: Dovish Policy + Upgraded Growth Expectations

In this scenario, the market prices in both Federal Reserve easing and an upgrade of U.S. economic growth expectations by 50 basis pointsRisk assets performed the strongest, with significant gains in the stock market, a slight decline in bond yields (balanced by the dual impact of dovish policies and enhanced growth), and a moderate overall weakening of the dollar, particularly evident against cyclical currencies. Adjusted for volatility, the rise in the stock market and the decline in the VIX index were most prominent.

The decline in yields, weakening dollar, and rising gold show consistency

Goldman Sachs summarized that, based on four scenario analyses, the decline in yields, strengthening of the euro/yen/franc, and rising gold performed consistently across various scenarios; furthermore, the direction of the stock market depends on the accurate assessment of growth expectations, and the strength of risk currencies against the dollar is similarly influenced.

Goldman Sachs also added that under a dovish policy combined with a positive growth scenario, the rise in the stock market is the best expression, while under a dovish policy combined with a negative growth scenario, the decline in yields is the most attractive.

Additionally, the market has begun to price in Federal Reserve easing, and if the data aligns, this trend may continue further.

Goldman Sachs' growth benchmark analysis shows that the current market pricing for growth is slightly above its one-year forecast, but if the market shifts to the 2026 growth outlook, there is still upside potential. However, significant weakness in growth and employment data may reignite growth concerns, becoming another pathway to drive interest rate cut expectations.

Goldman Sachs believes that if the growth backdrop is solid, the Federal Reserve's dovish shift could become a tailwind for risk assets, although current growth expectations appear relatively full compared to April.