Dealers set risk management strategies for the rate environment ahead

At their December 2025 meeting, the Fed shared a goal of reaching 3% Fed Funds target rate over the coming years, at a pace determined by its twin mandates of inflation management and labor market support. At the most recent meeting, while the Chair Powell signaled no further action until more data about the impact of the Iran conflict was available, officials’ forecasts did not back away from its 3% goal for short-term rates.

Knowing where the Fed wants to go while planning for the variable paths it may take to get there provides the baseline for dealers to plan their risk management strategies. Additionally, for those who have not yet fully digested the rate changes over the past two years, the timing may be right to catch up on delayed balance sheet strategy work and integrate it with broader business planning efforts.

While the Iran conflict is a reminder that interest rates (and the events that drive them) are not always predictable, today’s volatility stems from more than global events:

• The interplay between tariffs and inflation is an open question that continues to spur debate.  Will the remaining tariffs hold at these levels following the Supreme Court decision that struck down the President’s use of IEEPA tariffs? Will the impact to prices truly be one-time?
• AI is distorting traditional measures of inflation by absorbing a greater share of overall investment capital. AI drives demand for the materials needed to construct data centers and the electricity to power them.
• Energy prices have been holding the inflation number down in recent months, but the Iran conflict has interrupted that pattern.

There are no guarantees when it comes to the Fed and interest rates. Many will remember that at the end of 2021, markets expected a couple of rate hikes (0.50%) in 2022. What happened that year? The Fed hiked seven times, totaling 4.25% (425 basis points). While there’s inherent variability around rates, there are indicators of what we can expect:

• We’ve got more rate cuts behind us than in front of us. We believe that short-term rates aren’t likely to fall much from here in the current setup—perhaps nearly to 3% but not meaningfully lower.
• Rates for the 10-year U.S. Treasury note might stay relatively range-bound. Rates for longer-term loans haven’t come down significantly, despite recent Fed cuts. The 10-yr U.S. Treasury yield, a benchmark for longer-term rates, is higher in the past six months and only marginally lower from a year ago.
• Kevin Warsh will begin to make his mark as the new Fed Chair. Warsh has historically been hawkish in wanting to see the Fed’s balance sheet shrink. He’ll feel pressure from the administration day one to lower rates. We’ll see this tension play out at each Fed meeting.

Being nimble and reactive may have been enough in the past, but today’s volatility calls for an elevated level of balance sheet risk management strategy that overlays the overall business strategy. Thoughtful preparation will enable you to enact your plans when opportunities for growth, organic or through acquisition, arise. Incorporate a broad view of debt across your entire balance sheet to create a comprehensive strategy with the following: