Economic Events and ForexJan 27, 20265 Min

The Federal Reserve’s Next Move: Will Rate Cuts Start Before 2026?

The Federal Reserve has already cut interest rates twice in 2025, lowering the rate to a target range of 3.75%-4.00% in October. This was due to US inflation remaining high at 3.0% over the last 12 months as of September. Another factor that is responsible for the interest rate cut is a deteriorating job market and pressure on consumer prices.

The next Federal Open Market Committee (FOMC) meeting is set for December 9-10. Based on the current trend, there is an expected 63% chance that the Fed will lower the Federal funds rate by another 25 basis points. Today, we will review the major factors driving the central bank's Fed policy decisions, US inflation trends, and the monetary policy outlook.

US Outlook: Rate Cuts Near as Jobs Data Softens

Recent findings by Goldman Sachs and a survey by Reuters economists indicate that there is a growing agreement that the US Federal Reserve is about to reduce interest rates in December. This is because the markets are currently moving towards a slow-growth, easing-policy environment.

• Approximately 80% of economists believe that there will be a 25 bps reduction in December.
• Projected post-cut policy rate will be 3.50% -3.75%.
• Goldman Sachs also predicts a reduction in December and two additional reductions in early 2026.
• Unemployment is expected to increase to approximately 4.5% in the coming year.

The ex-tariff inflation is basically almost the same as the objective of the Fed. This allows the policymakers space to relax without the danger of another price explosion. Fed Chair Powell, however, emphasises that a reduction in December is not yet definite because of the gaps in the data provided by the government shutdown and internal disunity.

Why it matters: A key benefit of rate cuts is that businesses can borrow at a reduced cost. A lower policy rate reduces borrowing costs for businesses, often boosting stock prices in growth sectors like technology and consumer goods.

Current Fed Policy Landscape

The current landscape reflects a balance between supporting a weakening job market and preserving credibility amid economic uncertainty.

• Shifted to Easing Policy: The Federal Reserve has shifted to an easing policy since mid-2024. It has lowered interest rates by 50 bps (basis points) in September and another 25 bps in October to help support employment and monitor inflation.
• Division Over Cuts In FOMC Minutes: A division within the FOMC was revealed in the minutes of September. 11 out of the 19 members indicated that they would be willing to cut again, suggesting two additional cuts prior to the year-end.
• Steady Labour Market Indicators: Unemployment rose to 4.3% as of August, and monthly private payrolls have slowed, adding only about 22,000 jobs (a sign of cooling rather than stable growth). However, the October labour report is impacted by the federal government shutdown.
• Achieving Maximum Employment and Price Stability: The central focus of the Federal Reserve is now to achieve maximum employment while also maintaining price stability.

US Price Trends: Where Inflation Stands Now

Here are the inflation trends that are currently unfolding in the US market:

1. CPI Rate Exceeded the Target Rate

The US has seen a continued high inflation rate. The overall Consumer Price Index (CPI) index for this period increased to 3.0%, up 0.1% compared to the previous month’s CPI inflation rate of 2.9%.

• Energy prices, up 2.8% YoY
• Shelter costs, steady at 3.6%

Both categories are large components of the CPI basket, so even moderate increases keep inflation elevated.

2. Services and Core CPI Inflation Uncertainty

Core CPI, which excludes volatile items like food and energy, has declined to 3.0%, but services inflation remains high at 3.8%. Because services make up a large part of household spending, persistent services inflation creates uncertainty about when inflation will return to 2%.

3. Forecasted Third-Quarter GDP

The third-quarter forecasts (i.e., the Wall Street Journal survey) are calling for a 2.7% annualised economic growth for the third quarter. A 2.8% real PCE also evidenced economic growth. However, the risk of the federal government shutdown could slow down the fourth quarter by 0.5% to 1% weekly, adding to pressures on Fed policy.

Both numbers suggest that consumers are still spending money, which helps keep the economy strong.

Investor Impact: Service sector inflation has persisted to such an extent that investors may expect interest rates to drop at a slower rate than previously expected. Therefore, investors may wish to invest in "defensive" type stocks (such as utilities), which tend to hold their value regardless of how long higher rates are maintained.

Evolving Inflation Pressures and Economic Indicators

CPI (Consumer Price Index) is the main measure of inflation. It shows how fast prices are rising for everyday goods and services. The Federal Reserve’s decisions on whether to raise, cut, or hold interest rates depend heavily on inflation. The Federal Reserve has one main way to fight inflation: raising or lowering the federal funds rate.

• When CPI levels remain elevated, the Fed will have no choice but to continue to set rates at a level that will help slow down price increases.
• On the other hand, evidence of slowing CPI will give the Fed the opportunity to reduce interest rates to stimulate economic growth.

In determining if the FOMC votes for a rate cut in December, the November CPI reading (forecasted to be ~2.99%) is key. If CPI remains "sticky" above the 2% inflation target, the path to lower interest rates will likely take longer and will become increasingly uncertain.

What to watch: If the 10-year Treasury yield keeps dropping despite high inflation, it signals the bond market expects a slowdown. This often makes bonds an attractive hedge against stock market volatility.

Here are the trends that are shaping expectations for monetary policy and guiding market sentiment:

• The Cleveland Fed shows a CPI of 2.99% and a core CPI of 2.95% for November. While this is a marginal decline from recent readings, both metrics remain significantly above the Fed's 2% target.
• There is a risk of short-term volatility if there is a split vote in December on FOMC Fed policy, according to State Street.
• Despite the increased rate of inflation, the bond market reaction was muted. The yield on the 10-year Treasury has declined 10 bps to 4.00%.
• Investors have reduced their expectations of a Federal Reserve interest rate cut in December.
• Delays to the October jobs report and the CPI report because of the shutdown create additional uncertainty.
• The new administration’s tariff increases 2025 PCE US inflation projections specifically to 3.1% (up from 2.5%). It is likely to decline as those tariffs are reduced.
• The PCE forecast revision to 3.1% from 2.5% regarding tariffs is right on target. However, the forecast that these tariff impacts will weaken by 2026 is uncertain.

Fed Meeting Expectations and Rate Cut Timeline

The next Federal Open Market Committee (FOMC) meeting will be on December 9-10. The market consensus is a 25 basis point cut to between 3.50-3.75%, as reported by both Goldman Sachs and Reuters. Here is everything you must consider before the meeting takes place:

• Focus of Powell’s Comments in October: Powell emphasised data dependency in October when he referenced the resiliency of the US labour market despite weak projections regarding the number of hires expected in 2024 and 2025.
• Fed Funds Rate Odds: As measured by the CME FedWatch Tool, there is a 63% probability of a December interest rate cut (compared to 72% in late October), with three additional cuts in 2026 down to 3.00%.
• Beige Book Analysis: The November 26 release of the Beige Book will provide insight into regional perspectives of economic activity. However, the analysis may be distorted due to the government shutdown.
• Timing of Next Cut: Both trading economics and US banks expect a reduction in interest rate cut to occur unless the November 13 CPI report reveals a headline inflation rate of greater than 3.0%.
• Pause Scenario: If inflation rates prove more desirable than anticipated, the pause may be delayed until at least the first quarter of 2026.

In addition to monetary policy outlook implications regarding the timing of ending quantitative tightening (QT), the enhanced liquidity resulting from the termination of QT will have a positive effect on housing and other rate-sensitive sectors of the economy.

The takeaway: A pause scenario poses a threat to investors who are counting on interest rate decreases to be implemented immediately. Short-term bonds or high-yield savings accounts can diversify your portfolio by keeping your cash liquid while you wait for the central bank to commit to lowering interest rates through 2026.

What Markets Expect (and Why That Matters)

Traders are expecting the Federal Reserve will cut interest rates again by the end of the year. They gauge this through simple tracking mechanisms, such as the CME FedWatch, which shows around 50-65% odds of a cut in December based on investor willingness to pay.

These expectations drive everyday financial decisions, including the effects on long-term lending rates (mortgages). This reduces the spread between business loan interest rates and makes investors more likely to invest boldly in stocks.

Conclusion

The next move of the Federal Reserve will be based on finding a balance between addressing the US inflation and the slowing job market. This December meeting will be an important one for possible interest rate cuts before 2026.

Markets need some relief. However, the FOMC's disagreements over direction, along with the uncertainty surrounding economic data, stress the importance of flexibility to achieve a successful landing. Staying informed on these shifts can create investment opportunities in an easy monetary policy outlook.

Ultimately, turning data into decision-making: An easing environment will favour moving money from cash into long-term investments, such as bonds and equities, to lock in yields prior to the eventual lower interest rate environment.

Disclaimer: The information provided in this article is for educational and informational purposes only and should not be considered financial, investment, or trading advice.