Is the Fed Done Until 2026?

• The Federal Open Market Committee (FOMC) lowered the federal funds target range to 3.75%–4.00%, bringing cumulative cuts to 150 basis points (bps) since last September. Chair Jerome Powell cast doubt on another rate cut in December.
• The Fed’s balance sheet wind-down will conclude on December 1. Maturing securities will be reinvested in U.S. Treasuries, and the total size of the Fed’s balance sheet will be ~20% of U.S. GDP vs. mid 30% at peak.
• Two committee members dissented on the rate cut. Fed governor Stephen Miran favored a larger 50-basis-point cut, and Kansas City Fed President Jeffrey Schmid preferred no change in rates.
• Powell emphasized during his remarks that committee views differed sharply, uncertainty is high, and there is “no risk-free path” ahead.

Chair Jerome Powell’s comments regarding the Fed rate cut this week inform my view that the Fed is inclined to pause until 2026.

While the official policy statement remained neutral and in past meetings policymakers have been clear that monetary policy is not on a preset course, Powell’s most recent comments suggest a shift. During the highly scripted portion of the press conference, Powell said, “A further reduction in the policy rate at the December meeting is not a forgone conclusion—far from it.”  For me, this indicates Powell now intends to skip December and continue to assess. Given what we know today about the state of the economy, barring a change in economic signals, a pause seems likely.

Powell acknowledged sharply differing views within the FOMC. When the minutes are released, they will likely show a deeper philosophical and political divide rather than simple disagreement on the economy and the path of rates. Underlying economic conditions have not changed materially, yet the language is notably different in this week’s FOMC meeting.

Also, this week the Fed announced the end of quantitative tightening. Starting in December, the Fed will cease the runoff of its Treasury holdings and will replace maturing mortgage-backed securities with short-term Treasury bills. While this garnered media attention, I see it as a nonevent. The Fed is acknowledging some market funding pressures, but while its balance sheet is much larger than before the global financial crisis, it’s well below peak size. There’s simply nothing magical about a specific balance sheet level.

The Factor that Could Shift the Fed

Aside from inflation moving higher or employment weakening, watch inflation expectations. Powell dropped a strong clue when in the context of the Fed’s “dual mandate” he said, “we remain committed to maximum employment and keeping longer term inflation expectations well anchored.”  To me, that phrasing indicates that any rise in inflation expectations could push the Fed toward focusing more on inflation risk than unemployment risk. I also believe the longer inflation stays near 3%—roughly where the U.S. Consumer Price Index (CPI) has hovered since June—the greater the risk the public will expect it to remain there, above the Fed’s 2% target.

Of course, as I write this, the government shutdown continues to delay the release of CPI and other economic indicators. However, the Fed can rely on alternative sources of economic data and anecdotal business feedback. I believe its economists can provide enough information to the FOMC to make a December decision, regardless of the shutdown.

Investment Implications

Prior to this week’s FOMC meeting, markets were pricing a >90% likelihood of a cut in December and at least four additional cuts in 2026, despite stubbornly high inflation and some firming economic indicators. This was a set up for a dose of reality; these high odds were simply beyond what was justifiable, and Powell is right to push back.  If underlying growth is on strong footing, and I believe it is, then there may be less reason for the Fed to continue its cutting cycle. This week’s push from the Fed suggests they too may see that stronger conditions potentially mean a shallower cutting cycle, a risk the market had been ignoring.

Broadly, I remain constructive on the underlying economic backdrop as there are very real tailwinds from higher tax rebates in 2026, deregulation, an impetus for ongoing capex spending coming from the One Big Beautiful Bill, and constructive earnings from companies that should lead to better employment conditions. These are good for the underlying economy, but they are likely to lead to fewer cuts, and overall higher rates, especially at the long end of the curve as well as stubborn inflation. While higher rates pose a risk to credit spreads and stock multiples, they also increase the potential income that fixed income investors count on.

In any case, a shallower cutting cycle today, if it comes to fruition, should result in a deeper cutting cycle when the economy does eventually turn, and then fixed income investors would stand to benefit from rising bond prices that occur as yields eventually fall—offsetting potential weakness in other areas of a portfolio. We see a compelling opportunity today for investors to focus on the outcomes they seek from their fixed income holdings and take advantage of a window for higher income and ballast to portfolios.

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