December Fed Meeting – Not a Hawkish Cut After All

Paresh Upadhyaya - SVP, Director Fixed Income and Currency Strategies

Executive Summary
The Federal Reserve (the Fed) voted 9-2-1 to cut the Fed Funds rate by 25 basis points (bp) to a range of 3.50-3.75%, marking the third consecutive Federal Open Market Committee (FOMC) meeting at which rates were cut. There were two hawkish dissenters with Austan Goolsbee and Jeffrey Schmid preferring no change in rates, and one dovish dissenter, Stephen Miran, who advocated for a 50 bp rate cut. Overall, we thought the FOMC Statement and Summary of Economic Projections (SEP) was less dovish, but that was offset by a more dovish-than-expected press conference. The FOMC Statement repeated language used in the December 2024 statement that is likely to signal a pause in its easing cycle at the January FOMC. Further justifying the meeting’s less dovish tone, the refreshed SEP saw a sharp upward revision to 2026 Gross Domestic Product (GDP). On the other hand, the updated forecasts of future Fed Funds rates, or the “dots”, saw no change in rate cut forecasts in 2026 and 2027. This brought the median expectation to one 25 bp rate cut by year-end 2026 and 2027. Financial markets reacted positively, contrary to expectations. Government bonds and equities rallied while the US Dollar (USD) depreciated modestly.

Key Takeaways

• Fed Funds Rate: The Fed cut this rate by 25 bp to 3.50-3.75%.
• FOMC Statement: Altered to signal a likely pause at the January 2026 FOMC meeting.
• Fed Funds “Dots”: While there was a wide range of FOMC views, the median forecast still anticipates one 25-bp cut each in 2026 and 2027, unchanged from September.
• Summary of Economic Projections (SEP): Upward revision to 2026 GDP and downward revision 2026 core Personal Consumption Expenditures (PCE), with no change in the unemployment rate forecasts.
• Press Conference: Federal Reserve Chairman Jerome Powell’s overall tone was dovish but acknowledged that rates are at or near neutral.

FOMC Statement – One Major Edit to the Statement Signaling a Pause at the Next Meeting
There were some changes to the FOMC Statement. The most significant change was the Fed’s insertion of “the extent and timing of” into the forward guidance of the statement. The Fed lifted those words from the December 2024 FOMC Statement. After that language was inserted, the FOMC paused at cutting interest rates at the January 2025 meeting. Similarly, we are expecting the Fed to pass at adjusting the Fed Funds rate at the January 2026 FOMC. There was a minor edit to the current labor market assessment, which no longer characterizes the unemployment rate as low. Finally, the Fed said it will begin to purchase short-term Treasury securities now that “reserve balances have declined to ample levels” to maintain ample reserves. 

The SEP and Accompanying “Dots”: Two Changes to the SEP, but No Changes to the Dots

• Notably, the Fed revised its 2027 growth forecast from 1.9% to 2.0% and raised its 2028 forecast from 1.8% to 1.9%.
• There was a small downward revision to the Fed’s Core PCE projections. The 2026 forecast was lowered from 2.6% to 2.5%. The Fed does not expect to hit its 2% inflation target until 2028, a timeline that remains unchanged since September’s SEP.
• There was no change in the Fed’s unemployment and Federal Funds rate projections.

Specific to the Fed Fund’s Rate “Dot Plot”

• Year-end 2026: The median dot decreased from 3.625% to 3.375% - implying one 25 basis point cut.
• Year-end 2027: The median dot declined from 3.375% to 3.125% - signaling one 25 basis point cut.
• Year-end 2028: The median dot remained unchanged at 3.125%.
• Long-term: The median dot remained unchanged at 3.00%. Note: this is commonly referred to as the “neutral rate” and should be compared to the Fed’s long-term inflation target of 2.00%.

Press Conference: A Dovish Tone

Chair Powell’s press conference struck a notably dovish tone, and there were several key takeaways:

• He noted the Fed now believes monetary policy is at the high end of neutral which implies the need for a near-term pause to gauge the impact of prior rate cuts on the economy.
• He downplayed the sharp 0.5% upward revision to GDP as it pulled 0.2% from 2025 GDP due to the impact from the government shutdown. Otherwise, the economic growth would have been more balanced at 1.9% in 2025 and 2.0% in 2026.
• Chair Powell remained sanguine on inflation, pointing out that PCE Core ex tariffs would see inflation in the low 2s rather than the current level of 2.8%.
• The labor market is still the higher focus in the Fed’s dual mandate as Powell highlighted a systematic overcount in the nonfarm payrolls and we are likely to see monthly payroll employment being revised down to -20k from the +40k currently reported.
• Finally, regarding today’s reserve management purchase announcement, he noted that the move from abundant to ample reserves came more quickly than expected and that purchases of short-term securities are front loaded to get reserves high enough to get through the April 15 Tax Day which usually sees funding market stress.

Market Reaction and Investment Implications
Market Reaction: Dovish Fed Sparks Strong Rally in Financial Markets

Overall, we interpreted the December FOMC meeting as dovish, relative to market expectations. The market rally gained momentum with help from various factors such as Chair Powell pushing back on the Fed contemplating hiking rates, noting the post-shutdown boost to the 2026 GDP upgrade and discussing a weaker labor market than was appreciated by markets. Chair Powell had a dovish impact on US Treasuries, reversing a hawkish reaction to initially patient rhetoric. Government bonds and equities rallied while the USD depreciated modestly by 0.33%. Specifically, the US Treasury curve steepened with yields declining in years 2, 10 and 30 by 5 bp, 2 bp and 0 bp, respectively. The major US equity indices all closed approximately 0.8% higher.

Investment Implications

The December FOMC Statement, the updated SEP and Chair Powell’s press conference make it clear the Fed is maintaining optionality and that the bias remains to ease monetary policy. Chair Powell repeated the mantra that monetary policy is not on a preset course and that the decision will be made on a meeting-by-meeting case. Chair Powell’s focus on relatively high productivity suggests a more patient Fed comfortable with letting the economy grow slightly on the stronger side while tolerating inflation a little above target. However, in light of the healthy economic backdrop and elevated inflation, we think the bias remains for higher long-term Treasury yields rather than lower. As such, we continue to position portfolios around themes of neutral interest rate duration with modest curve steepener positions in place, higher credit quality, and selective overweight positions in securitized credit and insurance-linked securities. The USD remains vulnerable to the prospect of lower short-term interest rates, relatively expensive valuation, and large twin deficits. We expect equity markets will benefit from a relatively accommodative monetary policy and should benefit from a focus on organic earnings growth. 
 

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