What is a central bank to do when it is flying blind?

The U.S. stock market is being powered by the same tech-heavy optimism that has driven momentum all year. The S&P 500 and Nasdaq have been lifted by AI-related stocks including Nvidia and AMD — brushing aside the discomfort of the U.S. government shutdown.

But beneath the surface of this euphoria lies growing anxiety about the next big macroeconomic event: the October meeting of the Federal Open Market Committee.

That meeting — set for Oct. 28-29 — comes at a time when the Federal Reserve has to decide on monetary policy without the full panoply of government data it would ordinarily rely on. This poses not just operational questions for the Fed, but also philosophical ones: What is a central bank to do when it is flying blind?

This is not without precedent. The longest U.S. government shutdown came in late 2018 and carried into early 2019, lasting 35 days. That one delayed government data too, forcing the Fed to use private-sector proxies and market-based indicators.

This time the risks may be greater: The U.S. economy is slowing, fiscal policy is in turmoil and monetary policy is already tight. Doing the wrong thing or sending the wrong signal could unsettle markets, tighten financial conditions unnecessarily or allow inflation to reaccelerate.

Almost all the conjecture heading into this week’s Fed meeting is focused on whether the Fed will lower the key rate by 0.25%, or 25 basis points. Market participants are seeing this as the base-case scenario, but the wording and tone the Fed uses will be most important.

Should the Fed reduce rates but continue hawkish rhetoric, markets might sell off. Stocks would initially celebrate the reduction, but any Fed caution about a persistent inflation menace would inflate real yields and the U.S. dollar, putting growth stocks in trouble. Gold, which lives on real-yield compression, would decline under these circumstances, and margin positioning would be quickly unwound in high-beta stocks.

On the other hand, a 0.25% rate cut with dovish commentary would likely be viewed as the beginning of an easing cycle. If Fed Chair Jerome Powell and team highlight risks on the downside — including softening labor-market conditions or weakness in the economy globally — markets would pop much higher. The dollar would fall, gold would break to the upside and risk appetite for equities and crypto would go through the ceiling.

This is the “soft landing plus liquidity” scenario, and what the market bulls are betting on.

There is also a chance for a more forceful Fed move — a 0.50% (50-basis-point) reduction. This would be done only if private data or financial-market distress indicates things are breaking faster than expected.

An intervention on that scale would indicate the Fed recognizes imminent recession danger or credit distortions. If accompanied by dovish rhetoric, such a move would induce a euphoric response for risk assets — stocks, crypto, gold — nearly everything goes up. But such a bold move could also stoke panic that the Fed recognizes something the general public doesn’t. In that scenario, the initial surge would be followed by a defensive rebalancing, particularly if investors start searching hard for hints of systemic weakness.

Yet another underexplored outcome is the Fed holding rates steady while issuing dovish guidance. This would be a classic “wait-and-see” approach, particularly if the shutdown delays too much economic data to justify immediate action. The Fed could say, in effect, “We’re not cutting now, but we’re prepared to if conditions worsen.” That sort of stance could be well received by equity markets, depending on how credible the guidance is. But if markets interpret the pause as fear or indecision, volatility would rise sharply.

If Powell delivers a message too cautious for the data that eventually comes out, or too aggressive for what investors are bracing for, the reaction could be violent.

And lastly, the doomsday scenario for markets: The Fed keeps rates unchanged and sends a hawkish signal. This is the type of message that would be reasonable if inflation data is lagging but still too uncomfortable in the Fed’s alternative trackers — or if wage growth and shelter inflation have not cooled quickly enough.

Should Powell refer to such terms as “inflation persistence,” “premature easing” or “financial conditions too loose,” markets will interpret it as the message that rate cuts are not on the horizon anytime soon. In that event, prepare for a precipitous selloff in the S&P 500, a rising dollar, weakness in gold and extreme distress in highly leveraged trades.

What the Fed says will matter more than ever. With official unemployment, CPI and wage data potentially missing, Powell may lean more heavily on “soft” indicators including ISM surveys, jobless claims and market-based inflation expectations. That’s problematic. These proxies are often volatile and backward-looking. And that’s where the risk lies — if Powell delivers a message too cautious for the data that eventually comes out, or too aggressive for what investors are bracing for, the reaction could be violent.

Politics vs. policy

Above the policy imperatives, politics is fueling the frenzy. The longer the government shutdown continues, the more economic friction is caused. Paychecks delayed for federal workers, delayed contracts, halted construction projects — these second-order effects will start showing up in earnings, consumer data and sentiment.

With tensions running high, even a Fed cut may not be enough to soothe fears. Investors need to be actively gearing up for all these possibilities — not just the expected one. That entails following through on real yields, volatility indexes and FX positioning.

Gold is still one of the best hedges in asymmetric environments, especially if the Fed overcorrects or is no longer in control of the narrative. With stocks, be picky. Avoid chasing the index. Look at firms with pricing power, solid balance sheets and low interest-rate sensitivity.

The Fed’s job is never straightforward. But when it has to navigate the largest economy in the world without having all the dashboard tools, that is exponentially harder. The market expects a soft landing for the economy. Whether the Fed supports or shatters that perception depends on what it says, not what it does.