The Federal Reserve cutting interest rates this year would reduce the risk of a "panic freeze-up" in the financial markets, Jim Paulsen, chief investment strategist at The Leuthold Group, said Monday.

A rate cut combined with President Donald Trump's compromise with Mexico and a possible U.S.-China trade deal could create "a heck of a rally as this year progresses," Paulsen told CNBC's Brian Sullivan in an interview on "The Exchange."

U.S. stocks were higher Monday after Trump announced Sunday that the U.S. reached an immigration agreement with Mexico, taking proposal to slap 5% tariffs on Mexican goods off the table. The weekend news eased some trade concerns for investors as the bigger U.S.-China trade dispute continues to rattle financial markets and threatens to drag on the global economy.

The Fed currently holds its benchmark funds rate in a range of 2.25% to 2.5%. Some traders are betting on a quarter-point cut in July and possibly more later this year to make up for the potential U.S.-China trade war damage. However, in a note to clients Monday, Goldman Sachs warned that the growing consensus that the Fed will cut rates soon is misguided.

Earlier this month, Paulsen said the U.S. couldn't have picked a better time to increase tariffs on China because price pressures are so low that the Fed would actually welcome any increases in inflation. U.S. tariffs on Chinese imports would have to go on for a "considerable period of time" before price increases would cause any troubling inflation, he added.

The U.S. and China are currently stalled on talks to find an end to the trade war between the world's two largest economies. In May, the U.S. increased duties on $200 billion worth of Chinese products from 10% to 25%. Shortly after, China announced plans to raise tariff rates on $60 billion in U.S. goods.