A divided Fed lowers rates by another quarter point and scales back its projections for 2026 moves

Executive summary

Federal Reserve (Fed) policymakers lowered the federal funds rate by 25 basis points (0.25%) to a range of 3.50% – 3.75%. This was the third rate cut in as many meetings. Additionally, the Fed will begin buying $40 billion of Treasury bills (T-bills) to build reserves.

Again, the committee remains divided as three voters dissented today – one in favor of a larger 0.50% rate cut, while two others preferred no change. While a sign of healthy debate, more dissents likely mean increased interest rate volatility.

Stocks jumped on the news of today’s rate cut, while bond yields declined with the sharpest move concentrated in the front end of the yield curve.

With today’s rate cut, it appears that the Fed effectively pulled forward one of its 2026 rate cuts. Moreover, Fed Chair Jerome Powell noted that the federal funds rate is closer to neutral. We see that as a signal of continued gradualism in future rate moves on their way towards 3%.

What Happened?

At its December rate-setting meeting, the Federal Open Market Committee (FOMC) lowered the target range for the federal funds rate to 3.50% – 3.75%. It was the third consecutive meeting with a 25-basis-point (0.25%) rate cut.

There were three dissents as Fed Governor Stephen Miran wanted one in favor of a larger 0.50% rate cut, while Kansas City Fed President Jeff Schmid and Chicago Fed President Austan Goolsbee preferred no change. Governor Miran has voted for a half-point rate cut in all three of his meetings on the committee. It was also the fourth consecutive meeting with at least one dissent.

The Fed also announced that it will begin buying $40 billion per month of Treasury bills starting on December 12th. Chair Powell said the reason for buying T-bills, which mature within one year, is to rebuild reserves in the financial system. Powell categorized it as more of a temporary move to provide liquidity ahead of seasonally light periods, such as tax time, when the government is making tax refunds in February and March, but tax payments tend to occur closer to April 15th. That’s a sequencing issue rather than a sign of liquidity issues.

The FOMC also released an updated Summary of Economic Projections, which now sees more economic growth in 2026 and 2027. Near-term inflation forecasts are lower than September’s, while the outlook now pencils in just one rate cut each in both 2026 and 2027.

Chair Powell maintained a cautious tone, stressing that the committee remains data-dependent. He emphasized that policy is not on a preset path and preserving maximum flexibility on future rate decisions.

As expected, Powell steered clear of specifics. However, he stated that “adjustments to our policy stance since September bring [the federal funds rate] within a range of plausible estimates of neutral.” Our read is that the committee feels it’s closer to neutral.

Powell also sidestepped several thorny questions, including those related to Supreme Court decisions, both for tariffs and for a president’s power to fire independent agency heads, along with those regarding his job and whether he’ll stay on after his term as Fed chair expires (since his term as Fed governor doesn’t expire until January 31, 2028).

Our Take

We aren’t surprised by today’s rate cut nor the growing likelihood that the Fed will pause rate cuts in January. We’ve been saying for some time – and continue to believe – that the Fed would probably lower the federal funds rate in December or January, but not both. That is now reinforced by Chair Powell’s assertion that the target rate is closer to neutral.

Additionally, we agree that the backlog in the economic data muddies the proverbial waters. Although the statistical agencies have done a great job of quickly releasing most series current through September, much of October’s data is still delayed, and some cases, can’t be recreated and thus won’t be released. In many instances, data for October and November will be combined when it's released this month and next. That includes key inflation data.

Furthermore, the Supreme Court decisions, especially for tariffs, could impact inflation. There’s also the potential for another government shutdown in January since funding will expire on January 30th – two days after the January FOMC meeting. Each of these could influence the calculation for a January rate cut. Alas, it makes sense to move cautiously.

Lastly, while dissents are relatively rare – representing about 6% of all Fed monetary policy votes going back to 1957, we view these as the hallmarks of a healthy debate rather than a risk to worry about. In fact, such debate and dissents are common at other central banks; most prominently, dissents frequently occur at the Bank of England. Nonetheless, we’re not surprised given the crosscurrents in the economic data. Conversely, it likely makes the Fed’s next move harder to predict, which could lead to greater volatility for interest rates.

We maintain our expectation that the Fed will lower the federal funds rate towards 3% in 2026, albeit gradually.

Bond Market Implications

Like the Fed, bond market participants have had to piece together their Fed rate cut expectations through sporadic economic data releases. Government-sourced labor and inflation data remain delayed due to the six-week-long shutdown, with much of the October data still pending or scrapped. Recently, the bond market has grown more sensitive to private and alternative data sources, which are typically viewed as secondary to the major releases from government agencies like the Bureau of Labor Statistics. For both the Fed and bond traders, the effort to cobble together a clear economic picture continues.

In the six weeks since the Fed’s October meeting, alternative data releases have pointed to a cooler – not collapsing – labor market and sticky – not accelerating – inflation. Against this backdrop, traders increased bets that the Fed would move forward with a third consecutive rate cut. Fed funds futures placed a 93% chance of a rate cut ahead of today’s FOMC rate decision, up from a 29% implied probability on November 19th. Over that span, T-bill yields dipped to reflect the rising perceived chance of a cut. However, yields beyond 2-year maturities have risen, which is an atypical reaction in anticipation of a rate cut. Rising global yields – particularly in Germany, Japan, and Australia – contributed to the counterintuitive move. Also, rising U.S. Treasury term premia (i.e., the amount of additional compensation investors require to invest in the face of uncertainty) are partially to blame. Market participants remain concerned about the rising budget deficit and the robust U.S. government debt issuance expected in 2026. The 10-year U.S. Treasury bond was trading at 4.16% heading into the FOMC meeting, near its highest point since early September.

In the wake of the rate decision and Powell’s press conference, yields extended their morning declines with the strongest move concentrated in short-dated maturities. The Fed’s announcement of short-dated government bond purchases starting on December 12th should boost market liquidity conditions. However, we view this change as a technical, market-driven decision rather than a shift in monetary policy.

U.S. interest rates will remain very sensitive to fiscal and trade policy developments and the deluge of economic data expected between now and January’s FOMC meeting. 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

Despite crosscurrents and a laundry list of uncertainties, we maintain our expectation that the Fed will lower the federal funds rate towards 3% in 2026, albeit gradually.