Economic Commentary

Executive Summary

As widely expected, Federal Reserve (Fed) policymakers lowered the federal funds rate by 25 basis points (0.25%) to a range of 3.75% – 4.00%. This was the second rate cut in as many meetings.

Notably, today’s decision to lower the federal funds rate by 0.25% received two dissents from voting members – one in favor of a larger 0.50% rate cut (Fed Governor Stephen Miran), the other in favor of holding the benchmark rate steady (Kansas City Fed President Jeff Schmid).

Meanwhile, the committee announced that the Fed’s quantitative tightening program used to reduce the central bank’s balance sheet will conclude on December 1st.

During the press conference, Fed Chair Jerome Powell largely preserved his cautious, data-dependent tone. He reiterated that monetary policy is not on a preset course. He maintained maximum policy flexibility around future rate decisions but underlined that a rate cut in December is “far from” a foregone conclusion. In response, U.S. Treasury yields jumped, and stocks erased earlier gains.

The Fed’s rate decision in December will be driven by the economic data received over the next six weeks; however, the embargo on government-sourced economic data because of the ongoing government shutdown complicates the Fed’s analysis of current conditions. Overall, we believe the Fed will spend the first half of 2026 lowering the federal funds rate to roughly 3%. 

What Happened

At its October rate-setting meeting, the Federal Open Market Committee (FOMC) lowered the target range for the federal funds rate to 3.75% – 4.00%, its second consecutive meeting with a 25-basis-point (0.25%) rate cut.

Additionally, the Fed will end its balance sheet runoff (i.e., quantitative tightening, or QT) on December 1st. The monthly redemption caps on U.S. Treasury securities and agency mortgage-backed securities had been set at $5 billion and $35 billion, respectively, since March. Starting December 1st, the Fed will take action to hold the size of its balance sheet steady near $6.6 trillion.

The FOMC won’t release an updated Summary of Economic Projections, which forecasts the future paths of policy rates and the U.S. economy, until its next meeting on December 10th.

In his prepared remarks during the post-meeting press conference, Chair Powell discussed the recent softness in the labor market, characterized by an environment where both hiring and layoffs appear low. Additionally, he acknowledged that inflation has ticked up slightly relative to readings earlier this year. When discussing future policy decisions, Powell firmly stated that a rate cut at the December FOMC meeting is “far from” a foregone conclusion and that incoming data would drive shifts in the Fed’s policy stance.

Powell repeated that the committee was fully dedicated to returning inflation to the Fed’s 2% target level, but the inflation outlook remains clouded by global trade negotiations. As a result, there is a rising number of disparate views among Fed officials about the future path for monetary policy. Powell mentioned that there is a “growing chorus” of participants that believe pausing rate cuts soon to assess the health of the economy may be the next prudent move.

Our Take

As we expected, the Fed moved forward with a second consecutive rate cut on its journey to returning the federal funds rate to a more neutral setting near 3%. Around this level, the Fed is likely to assume that policy rates are neither slowing nor accelerating the economy in a material way. Furthermore, ending QT was also expected, which Powell prefaced in a key speech earlier this month.

In light of Powell’s comments and the dissents at today’s meeting, a third consecutive rate cut at the December FOMC meeting isn’t a lock. Recent inflation readings have been more benign than feared and the labor market has slowed meaningfully over the past five months. That has raised the chances of one more rate cut by year end, but the disruption in economic data provided by government agencies and the continued whipsaws in U.S. trade policy complicate Fed policy decisions in the very near term. What matters most now is the action the Fed takes in the next 6–12 months. We continue to expect the Fed to lower the federal funds rate to a more neutral setting near 3% as we progress through 2026, although we anticipate the pace will continue to be gradual.

Aside from Powell’s comment that a rate cut in December was “far from” a foregone conclusion, one of the biggest developments at today’s meeting was the announcement that quantitative tightening will conclude on December 1st. There is growing evidence within money markets that liquidity conditions have deteriorated modestly. By ending its balance sheet runoff, the Fed aims to prevent a repeat of September 2019, where a shortage of cash in the financial system caused interest rates on very short-term loans to spike considerably. In an emergency response, the Fed injected a massive amount of liquidity to stabilize the situation.

Bond market implications

Since the Fed’s September meeting, U.S. Treasury yields have trended lower as traders boosted bets that the central bank would continue to ease policy in response to benign inflation data and labor market sluggishness. The 10-year U.S. Treasury yield has been testing the 4% threshold for the past two weeks and dipped slightly below 4% again headed into today’s rate decision. Earlier this month, the 2-year U.S. Treasury yield – which is very sensitive to Fed policy – touched its lowest yield since August 2022 when the Fed was in the midst of its aggressive rate hike campaign.

Today’s 0.25% rate cut was well-telegraphed and widely expected. Thus, the rate announcement itself created negligible impact on the bond market reaction. However, Powell’s press conference, which was perceived as hawkish pushback against the market’s conviction that the Fed would keep delivering consecutive rate cuts, created a stir. Yields across the curve moved sharply higher, with the most pronounced recalibration concentrated in the first few years of the yield curve. U.S. Treasury bonds with less than 3-year maturities are the most sensitive to Fed policy. Powell’s comments challenged the views of the market’s most dovish traders, pushing the 2-year U.S. Treasury yield higher by 11 basis points (0.11%) to 3.61%, its highest point this month. The 10-year and 30-year U.S. Treasury yields jumped 9 basis points (0.09%) and 7 basis points (0.07%), respectively.

U.S. interest rates will remain very sensitive to fiscal and trade policy developments and incoming economic data, particularly with respect to inflation and the labor market. The market’s reactions to these factors may create tactical opportunities to adjust portfolio duration. However, the intermediate portion of the yield curve is currently trading near our assessment of fair value. Thus, we continue to recommend a neutral duration posture within a fixed income portfolio relative to intermediate benchmarks.

Bottom Line

The Fed remains on a gradual path towards a more neutral rate setting, likely near 3% barring a sharper slowdown in the U.S. economy. The uncertain endgame for U.S. trade policy and the disruption in economic data created by the government shutdown are likely to contribute the Fed’s cautious tone and slower pace.