Monetary Policy Update: December 2025

The Federal Reserve cut its short-term policy rate by 25 basis points for the third consecutive meeting, targeting a new rate of 3.50% to 3.75%.

This decision was widely expected, even with inflation remaining at somewhat-elevated levels. The Fed’s focus remains on the softening of the labor market, as job growth has slowed over the course of this year. In its accompanying economic projections, the Committee noted that “the extent and timing” of additional policy rate adjustments would depend on incoming data, the outlook and balancing of risks going forward. The Fed also announced its intent to resume purchasing short-term Treasuries as needed in order to help manage market liquidity levels. This comes on the heels of ending its Quantitative Tightening program at the beginning of December. Rather than letting its holdings of Treasuries mature without replacement, the Fed now plans to reinvest the proceeds into short-term Treasury bills, as well as purchase an additional $40 billion per month between now and April.

How did the markets respond to the news?

The market appeared ready for a “hawkish cut” and potential pause on rate cuts to start 2026 as equity markets broadly moved higher on the announcement. The Russell 2000 small cap index led the way, gaining 1.3%, while the S&P 500 was up over half a percent and the tech-heavy Nasdaq closed modestly in the green.

The U.S. Treasury curve steepened slightly ahead of the announcement as the market priced in short-term rates coming down. The 10-year rate fell about 5 bps on the day to about 4.15% as it has fluctuated between about 4.00 and 4.20% since early September. Longer-term rates have edged higher over the past couple of months, as uncertainty remains and the market is forecasting only one cut in 2026 and another in 2027 at this time.

What is the Fed's "forward guidance"?

Divisions in opinion are growing among voting members. Given that division, it was not surprising to see the Fed statement signaling a pause. Despite this signal, the median interest rate projections remained unchanged for 2026. As the environment remains ambiguous, the Fed did not provide much guidance on where policy was headed, but rather what it is dependent upon: confirmation of the stage of the economic cycle across a wide array of concurrent signals and conditions.

What will the Fed be most focused on throughout 2026?

The Fed will err on the side of caution, but it is in a precarious situation. The Fed’s message was direct: “Uncertainty about the economic outlook remains elevated.” Precursors of stagflation have caused unusual dissent amongst the Committee as members try to balance easing enough to bolster employment but not too much to spur inflation. In recent meetings, the Fed has deliberated without usual robust economic data, but datasets are expected to return to their previous periodic release schedule in 2026, giving the Fed a more current and clear assessment of conditions. The Fed has stated policy actions will be dependent on a wide array of information, including readings on labor market conditions, inflation pressures and expectations, geopolitics and financial developments.

After three consecutive cuts, monetary policy remains in restrictive territory — albeit, marginally — as the policy rate is seen to be slightly above the neutral rate. With ambiguous conditions eliciting debate within the Committee, policy adjustments are anticipated to be suppressed. The current dot plot forecasts only one rate cut in 2026. However, the circumstances are fluid, and tail risk events to the upside or downside may cause the Fed to react accordingly. In the press conference, the Fed acknowledged it is facing a challenging situation with a weakening labor market and stubborn inflation, but indicators suggest the economy is expanding at a moderate pace.

As always, we will continue to keep you updated on monetary policy as facts and circumstances change.