US monetary policy: Fed cut 25bps amid a divided committee

The US Federal Reserve has cut rates by 25bps amid a divided committee, signalling a possible pause as future policy moves remain data dependent post shutdown.

The economist view – Melanie Baker, Senior Economist

In line with consensus and market pricing, the US Federal Reserve (Fed) cut rates by 25bps to leave the Fed funds target range at 3.50-3.75%. This was again a split vote though. Board member Stephen Miran wanted a 50bps rate cut, while Austan Goolsbee and Jeffrey Schmid wanted to keep rates on hold. The decision to cut rates seemed largely centred on a shift in the balance of risks – with higher downside risks for the labour market. There was a change in the Fed statement from, “In considering additional adjustments…” to “In considering the extent and timing of additional adjustments…”. That additional language has been used before by the Fed to signal a pause.

The median projected policy path was left unchanged so there is still one cut expected for next year and one cut the year after

The statement did not paint a particularly downbeat picture and acknowledged that job gains have slowed but that inflation has moved up and “remains somewhat elevated”, while economic activity is expanding at a “moderate pace”. There were tweaks to the Federal Open Market Committee (FOMC) participant forecasts too, revising up growth forecasts for next year but down a little for inflation. The median projected policy path was left unchanged so there is still one cut expected for next year and one cut the year after, with the longer-run Fed funds rate still stuck at 3%. Again, the range of forecasts is wide though – next year ranging from 2.1% to 3.9%.

Fed chair Jerome Powell used language before around there being “no risk-free path” for policy at the moment with inflation risks tilted to the upside (in the near term) for inflation but to the downside for the labour market and said (again) that they are not on a preset path.  

Messaging from Powell in the press conference was somewhat mixed. There was language consistent with a pause, but some dovish elements too. I am forecasting a little more rate cutting from the Fed and, alongside the median participant projection for rates, that blend is arguably consistent.  

Pausing in January? Powell said that they were now within a “broad range” of estimates of neutral and said several times that they are now well positioned/well placed to see how the economy evolves. In terms of his own views, Powell also at one point implied he could make the case for either side of the policy argument.  

However, the idea of even a temporary pause in rates was somewhat offset by Powell noting that they will get a great deal of data by the next meeting that will factor into their thinking. He did, however, suggest that they would be looking at the next labour market and CPI prints with a critical eye, given the impact of the shutdown on data collection, understanding that the data might be distorted by some “very technical factors”.

A bit of dovishness from the chair Powell presented views on inflation in a relatively dovish way. He argued that disinflation is continuing for services and that much of the goods inflation was tariff related. He said that this didn’t feel like an economy that wants to generate inflation from tight labour markets for example. Then on tariffs he said that if there were no new tariff increases then inflation from tariffs should peak in the first quarter or so of 2026 and that it shouldn’t be a big impact. He said that inflation, if you get away from tariffs, is in the low two percentages. Then on the labour market he said that they think there is still overcounting in the payroll figures and that they were probably negative.

Reserves decision: Powell was clear in noting that there were no implications for the stance of monetary policy now that, given reserve balances have declined to “ample levels”, they will initiate short-term treasury security purchases for reserves management purchases.

The fund manager view – Craig Inches, Head of Rates & Cash

A very divided committee

The Federal Reserve delivered its third consecutive 25bp cut of the year, taking the target Fed funds range to 3.50–3.75%, but the details of the decision left the markets a bit confused. The vote itself was split highlighting three dissenters, two hawkish (wanted no change) and one dovish (Stephen Miran calling for a 50bp cut). Chair Jerome Powell’s press conference called the decision a “close call” and delivered the message that policy is now “within a broad range of neutral”. He emphasizes that there is no risk-free path and that balancing the upside inflation risks versus the downside employment risks was a difficult trade off. He highlighted that the Fed is not on a preset course and that the bar for further easing remains very data dependant from here. The new Summary of Economic Projections (SEP) and Dot Plot clouded the picture further – with seven members wanting no more cuts in 2026, four wanting one, and only a handful for two or more. In summary, a very divided committee that has no strong direction on the future path of interest rates at the moment.

The new Fed chair takes the reins in June, but don’t expect a free-for-all – the next leader will have to corral a divided group split between hawks and doves.

Markets had been stuck on the idea that the Fed would deliver at least three cuts next year. We’ve said all along that this felt overdone, based on the current economic data and our outlook for the US economy. It seems as if the Fed are of a similar view and are likely pausing for now. Unless the labour market collapses, it’s likely that the committee will sit tight until the new chair takes the reins in June. Even then, don’t expect a free-for-all – the next leader will have to corral a divided group split between hawks and doves, and that’s going to make 2026 more of a binary outcome: we either remain on a very shallow glide path lower if the mix of sticky inflation and labour decline persists, or a full-on easing cycle if the tariffs effects prove temporary and growth tanks.

What it means for rates

Markets will for now need to forget the notion of a Fed on autopilot, cutting rates to neutral or below, and instead focus on the data post shutdown which will be of key importance. Volatility in the front end of markets is likely to persist in the early part of 2026 as we await the new Fed chair. Positioning now for binary outcomes is the name of the game: either the economy cracks and cuts accelerate, or the Fed sits on its hands for now and the front end must reprice yields higher. Either way, last night’s decision was a reminder for the market that interest rate cuts are not a done deal – and we were right to fade the market’s enthusiasm of too much precautionary easing…. back to data watching!

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