The Federal Reserve will release its interest rate decision and summary of economic projections early Thursday morning.
The market widely expects a December rate cut by the Federal Reserve to be a foregone conclusion, but the core suspense of this meeting is no longer the interest rate itself. Against the backdrop of severe internal divisions and conflicting inflation and employment goals, the focus is on future policy guidance and how Powell will balance hawkish and dovish signals. Meanwhile, the upcoming change of Fed chair next year adds further uncertainty to monetary policy.
The market is focused on future policy guidance.
The unexpected negative ADP employment data in November, coupled with a weaker-than-expected September PCE price index, has led the market to bet that a Federal Reserve rate cut in December is virtually a certainty. The CME Group's FedWatch tool indicates that the probability of a 25 basis point rate cut by the Federal Open Market Committee (FOMC) in December is currently close to 90%.
However, as the most internally divided meeting during Federal Reserve Chairman Powell's nearly eight-year term, the interest rate itself was no longer the focus of the market; the real suspense and focus lay in the guidance of future policy paths.
Bai Xue, senior deputy director of the research and development department at Golden Credit Rating, told the Shanghai Securities News that there are significant disagreements within the Federal Reserve, with some officials expressing doubt or opposition to continuing to cut interest rates when inflation is still above the 2% target. The number of dissenting votes at this meeting may increase significantly, leading to a situation of two-way disagreement once again.
The quarterly economic projections and interest rate dot plot to be released at the meeting are also crucial. Bai Xue stated that the market will interpret the Fed's forecasts for economic growth, inflation, and unemployment in 2026 from these documents. More importantly, the dot plot will reveal officials' median expectations for the path of interest rates in 2026 and beyond, currently priced in at around 52 basis points (approximately two rate cuts).
Furthermore, the future direction of balance sheet management has become a focus of equal importance to interest rate decisions. Bai Xue stated that in order to alleviate the burden on banks... Given the shortage of reserves and pressure in the repurchase market, the Federal Reserve may announce a plan to start purchasing short-term Treasury bills monthly in January 2026 after halting balance sheet reduction. This would be seen as a technical expansion of the balance sheet, aimed at managing liquidity rather than a new round of quantitative easing.
"Eagle Dove" signal becomes the focus
Currently, the Federal Reserve faces a classic policy dilemma: inflationary pressures persist while labor market growth momentum weakens. This meeting falls precisely on the crossroads of its two major objectives: a 2% inflation target and full employment, which is the root cause of the growing internal divisions within the Fed. At this critical juncture, Powell's remarks at the policy meeting will be particularly important, as the market awaits signals on how he will balance these conflicting goals.
The market anticipates that this meeting will likely present a "hawkish rate cut" scenario, meaning that while implementing rate cuts, the Federal Reserve will convey a more cautious attitude towards future actions through verbal guidance and the dot plot. (CITIC Securities) Chief Economist Mingming told the Shanghai Securities News that the possibility of Powell releasing hawkish signals at the December FOMC meeting cannot be ruled out. Powell stated at the October FOMC meeting that "there is no zero-risk policy path, and the balance of risks has shifted." "The Fed's October rate cut is another step towards a more neutral policy stance." Overall, given the pressure on inflation, the Fed may be more cautious in assessing whether there are downside risks to US employment, and may therefore be more cautious in cutting rates.
Faced with the direct conflict between the two major goals of inflation and employment, the Federal Reserve's policy decisions will exhibit a dynamic balance resembling "risk management." Bai Xue stated that currently, the US job market is clearly cooling, while inflationary pressures are relatively controllable, providing a rationale for continuing interest rate cuts to prevent downside risks to the economy. However, the absolute value of inflation remains above the target, and the upward uncertainty due to policies such as tariffs will continue in the future, constraining the Fed's room for easing. Therefore, the Fed's balancing act is to use interest rate cuts to offset the cyclical risks of a weak job market, while simultaneously maintaining a certain degree of tightening pressure on financial conditions through hawkish rhetoric to anchor inflation expectations. Decisions will be highly "data-dependent," especially the assessment of whether inflation will fall as expected in the coming months and whether the employment decline is structural or cyclical, which will determine whether the policy focus leans towards inflation or employment.
The Bank of America report stated that if Powell fails to effectively convey hawkish signals, the market may price in a more aggressive rate cut in January in the short term.
"With the market paying close attention to the leadership transition, how Powell sets the tone for a smooth policy transition in the future, whether his speech leans towards a 'hawkish' stance to emphasize the determination to combat inflation, or whether he leaves room for flexibility in the future, will directly guide market sentiment," Bai Xue said.
The pace of interest rate cuts may slow in the first half of next year.
Regarding the future path of the Federal Reserve's monetary policy, industry insiders generally believe that, considering multiple factors such as economic fundamentals and inflation, the next significant "loose monetary policy" may not occur until after June next year.
Dongwu Securities In a research report, Chief Economist Lu Zhe's team stated that in the short term, the market has already fully priced in a December rate cut, absorbing all the dovish benefits. Therefore, attention should be paid to the hawkish risks arising from the press release at the December FOMC meeting, the dot plot guidance, and the number of dissenting votes. In the medium term, loose fiscal and monetary policies, along with seasonal stimulus, are expected to give the US economy a strong start to next year, preventing the Fed from cutting rates during January-April due to overheating.
Bai Xue stated that looking ahead to 2026, high tariffs will suppress imports, making it difficult for US inflation to fall, while restrictive immigration policies will lead to a decline in the labor force. Therefore, even with an economic downturn, the US unemployment rate is unlikely to rise significantly. All of these factors suggest that the likelihood of the Federal Reserve continuing to cut interest rates sharply next year is very low. It is expected that after the December rate cut, the Fed may pause its actions before June 2026 (i.e., before the new chairman takes office), entering a policy observation period. The reason for the pause is that by then, the policy rate will be closer to the neutral level, and the committee needs time to assess the effects of previous rate cuts and economic data, especially the trend of inflation. The market currently expects about 52 basis points, or about two rate cuts, in 2026. The first rate cut is highly likely to occur after the new chairman takes office in June, but the specific timing and number will depend heavily on the policy inclinations of the new Fed chairman and the evolution of economic data.
With the Federal Reserve set to change chairs next year, whether the Fed's monetary policy will enter a phase of "political interest rate cuts" has become a hot topic of discussion in the market as this interest rate meeting approaches.
Currently, Kevin Hassett, director of the White House National Economic Council, is the leading candidate for the next Federal Reserve Chairman, with the market expecting a high probability of him becoming the next Fed Chairman. Mingming noted that while Hassett may have some dovish leanings in monetary policy, he also emphasizes data-driven approaches. Recently, Hassett stated that "the responsibility of the Fed Chairman is to monitor the data, make adjustments based on the data, and explain to the public why they do so."
"In the long run, since the appointment of the Federal Reserve Chair still requires Senate hearings, and the core of the hearings is to assess the candidate's commitment to maintaining the Fed's independence, Hassett's words and actions are likely to be cautious and conservative before she officially takes office. The FOMC meeting next June may be the beginning of Hassett revealing her true colors and releasing dovish signals, at which time market expectations for further easing of monetary policy by the Fed may rise sharply again," said Lu Zhe, chief economist at Soochow Securities .
(Source: Shanghai Securities) (Report)
