Fed pauses as labor market stabilizes

Executive Summary

As widely expected, Federal Reserve (Fed) policymakers held rates steady in a range of 3.50% – 3.75%. It also continued its temporary buying of $40 billion‑per‑month U.S. Treasury bills to rebuild reserves.

Stocks and bonds remained relatively unchanged following the as-expected decision.  

We didn't expect any changes at this meeting, especially since the Fed had already cut rates by 1.75% total over the past 18 months, including at each of the three prior meetings. Looking ahead, we maintain our view that the next rate cut will be in the spring. More importantly, the timing of cuts at any particular meeting is less important in our view as the Fed continues heading towards 3% over the course of 2026.

What happened

At its January rate-setting meeting, the Federal Open Market Committee (FOMC) held the target range for the federal funds rate at 3.50% – 3.75%. Governor Stephen Miran again dissented in favor of a 25‑bp cut, joined this time by Governor Chris Waller.

It’s important to note that the Fed lowered rates at the three prior consecutive meetings by a combined 75 basis points (0.75%). The Fed also continued buying $40 billion per month of U.S. Treasury bills, which started back on December 12th and was intended to rebuild reserves in the financial system.

In prepared remarks, Chair Jerome Powell mentioned that monetary policy was “well positioned” to address the risks faced on both the dual mandate and decisions will continue to be made on a meeting-by-meeting basis based on incoming data and the balance of risks.

Powell maintained a cautious tone, emphasizing that the committee remains data‑dependent. He also noted that the economy was growing at a solid pace, the unemployment rate has been broadly stable, and inflation remains somewhat elevated. He explicitly mentioned that the downside risks to employment had lessened over the course of the past couple months.

Our take

Given a stabilization in labor markets over the past month-plus – namely, lower weekly jobless claims along with the unemployment rate slipping, the Fed chose to pause further rate cuts. That’s especially true after aggressively reducing rates by 1.75% beginning in September 2024, including 0.25% reductions at each of the three prior meetings.

Additionally, the pause is understandable as it comes in the aftermath of the government shutdown, which delayed and disrupted the release of a considerable chunk of key economic indicators while skewing much of the data. 

Still, too many of the government-sourced indicators are at least a month in arrears. This isn’t a criticism of the responsible agencies—who have been working to catch up—but simply an acknowledgment that the data backlog persists. This is why we’ve been saying that we probably won’t see a clean view of the economy until mid-to-late February, although that might extend into early March. We’re also hopeful that the looming partial government shutdown is avoided, which could potentially delay data further.

Chair Powell’s tone, demeanor, and comments appeared to convey that this pause might continue for the next couple meetings, which aligns with our expectation that the next rate cut will be in the spring.

In our view, the timing of cuts at any particular meeting is less important – we see the Fed taking rates towards 3% in 2026.

Bond market implications

Fed policymakers remain stuck between the two sides of their dual mandate – full employment and price stability. Recent data show inflation remaining stuck above target, though not reaccelerating as many feared following the initial tariff announcements in April. Meanwhile, the labor market has slowed significantly, with job growth falling to a five-year low. These crosswinds have left the U.S. Treasury yield curve treading water, with yields still a stone’s throw from their levels around the December rate decision. Headed into today’s rate announcement, traders had fully positioned for the Fed to pause and had pushed out expectations for the next rate cut into the summer. Thus, the initial reaction to the Fed leaving policy rates unchanged was very muted.

The Fed easing since September 2024 has already pulled short‑dated yields sharply lower—the 2‑year sits near 3.6%, over 160 bps below its late‑2023 peak. Intermediate and long‑term yields have fallen far less, reflecting policy uncertainty and heavy government issuance that continue to anchor longer maturities. The 10-year yield is roughly 70 basis points (0.7%) below its post-pandemic high, currently trading near 4.25%. The 30-year yield has only declined approximately 25 basis points (0.25%) since October 2023. 

We expect the Fed to take policy rates towards 3% this year, which should continue taking short-dated yields lower. That would also translate to lower investment yields, but also further relief in borrowing costs associated with credit cards, auto loans, home equity lines of credit, and small business loans. Furthermore, in an economic environment that warrants further rate cuts, we expect yields between 5- and 30-year maturities to decline as well, though likely to a lesser degree (i.e., the “stickiness” continues). Put together, this would lead to the U.S. Treasury yield curve steepening further, extending a two-and-half-year trend.

Currently, U.S. Treasury yields, which are the primary driver of core fixed income yields in general, are near our assessment of fair value. Thus, we reiterate our preference for a neutral portfolio duration stance. U.S. credit spreads continue to flirt with their lowest levels since 2007, which supports an up-in-quality bias until the risk-reward dynamic improves in lower quality fixed income via wider spreads.

Bottom line

The Fed paused rate cuts for now following the recent stabilization in labor markets. We maintain our view that the Fed will lower the federal funds rate towards 3% in 2026.