With inflation beginning to cool but many economic headwinds on the horizon, many on Wall Street are still debating as to when the Federal Reserve will begin to cut rates. Recent comments from Fed leadership continue to throw doubt on the Fed's next moves.

Vanguard Chief Economist & Global Head of Portfolio Construction Roger Aliaga-Díaz joins Yahoo Finance to discuss what are the conditions that need to be met for the Fed to make interest rate cuts and the possibility of where the economy might land.

Aliaga-Diaz claims the Fed needs "to see inflation in a sustained path downwards. This is difficult to think it will continue without further softening of the labor market. So it's the combination of inflation coming down with unemployment increasing which will actually trigger the cuts by the Fed."

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Nicholas Jacobino

Video Transcript

JOSH LIPTON: And, Roger, I'm also interested, what do you think the Fed needs to see before they start cutting? I mean, clearly we just saw the minutes. There's some uncertainty about if and when. Is it just, Roger, they need to see inflation come back to 2% and stick there for some amount of time as well as see the economy slowing?

ROGER ALIAGA-DIAZ: Yes, absolutely. They need to see inflation in a sustained path downwards. But again, I mean, this is difficult to think will continue without further softening of the labor market, right? So it's the combination of inflation coming down with unemployment increasing, which will actually trigger the cuts by the Fed.

What is very difficult to see is what the market is pricing in, right, because the market is pricing quite a few cuts. We know no increase in unemployment and with inflation coming down. So in our view, one of two scenarios can happen. Either the unemployment rate increases and the Fed cuts as much as the market is pricing in. Or alternatively, you have an employment remaining at 4% avoiding recession. But in that case, we don't see the Fed cutting as much, right?

So what is really difficult for us to see is this middle ground of more than four or five, six-- sorry, five, six cuts with unemployment at 4% and with inflation coming down.

JULIE HYMAN: So if there are these two binary scenarios here, Roger, how do you approach that as an investor? Are there sort of-- is there sort of a middle path that will be somewhat agnostic or that can succeed no matter which of those things comes to pass?

ROGER ALIAGA-DIAZ: Yeah. The way you're characterizing it is really the right way to think about it is a bimodal, right, a binary outcome. So the average of both of them is not the most likely outcome, right? And that seems what the market is pricing in. It's almost pricing in the middle of the two.

In our view, this binary outlook translates into probably volatility. We think that, on the one hand, the Fed may need to walk back a little bit the dovish rhetoric we heard in December. The minutes today are a little bit more neutral to respect. And also, the market probably will have to reprice more the Fed path in one of these two outcomes.

So it's-- I think we're concerned-- we're worried about the short term. This financial easing and this exuberance in asset in risk assets, we may see a little bit more volatility as this repricing happens, right? Medium term, we're more optimistic. But in the short term, we're more concerned about this.