Buckle up, kiddos. And keep your wallets and portfolios close.
The Federal Reserve heads into 2026 swirling in a messy mix of economic pressures and political uncertainties.
While the actual impact on interest rates remains to be seen, there is little doubt the takeaways from the December meeting of the Federal Open Market Committee are ripe with concerns about the turgid tensions in inflation rates and the job market.
Plus, there’s the Shakespearean drama engulfing the replacement of Jerome Powell when he steps down as chair in May.
Pass the popcorn.
Federal Funds Effective Rate Chart
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Interest rates drive monetary policy
Powell managed to secure votes on Dec. 10 for a third quarter-point cut this year.
The formal decision was 9-3, Bloomberg reported, but soft dissents showed not all policymakers agreed with the rate cut.
“We went into the meeting looking for a hawkish” cut, Priya Misra, a fixed-income portfolio manager at J.P. Morgan Asset Management, told The Wall Street Journal Dec. 12.
“It was not as hawkish as I think the market feared…so there was a sigh of relief on that front,” Misra said.
But wait, there’s more
One of the Fed officials who voted against the Dec. 10 cut is now saying he expects rates “can come down a significant amount over the next year.”
Federal Reserve Bank of Chicago President Austan Goolsbee said in a Dec. 12 statement that he is projecting more interest-rate cuts for 2026 than many of his colleagues.
He said he dissented against the December cut this week because he wanted to wait for more inflation data.
“Given that inflation has been above our target for four and a half years, further progress on it has been stalled for several months, and almost all the businesspeople and consumers we have spoken to in the district lately identify prices as a main concern, I felt the more prudent course would have been to wait for more information,’’ the statement said.
Fed’s dual mandate is a delicate balance
In its Dec. 10 announcement, the FOMC signaled it may pause cuts in the short term.
“In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks.”
The Fed’s dual congressional mandate requires it to balance inflation and job growth via interest rates.
- Lower interest rates support hiring but can fuel inflation.
- Higher rates cool prices but can weaken the job market.
The two goals often conflict, operate on different timelines and are influenced by unpredictable global events.
For instance, the government shutdown froze data from the leading economic indicators for October and November.
The September unemployment rate ticked up to 4.4%, and Personal Consumption Expenditures inflation came in at 2.79%, above the Fed’s 2% target.
- Applications for unemployment benefits rose for the week ending Dec. 6, the most since the beginning of the Covid pandemic.
- Initial claims increased by 44,000 to 236,000 in the week ended Dec. 6, according to Labor Department data released Dec. 11.
- That was the biggest jump since March 2020.
Cooling labor market sparked three 2025 interest-rate cuts
The benchmark Federal Funds Rate controls the cost of short-term borrowing (e.g., credit cards and auto loans).
The FOMC held the rate steady for most of the year.
Related: Fed cuts rates as dissents loom at key December meeting
This “wait-and-see” approach was driven by caution over tariff inflation and trade policy.
It then lowered it by a quarter percentage point in both September and October over labor market concerns.
The December cut trimmed the target range to roughly 3.50% to 3.75%.
Labor market risk raises concerns for some Fed officials
In his post-meeting press conference, Powell mentioned a labor risk that some economists have been mulling over.
Official government statistics could be drastically overstating recent hiring.
Government data could be overestimating job creation by up to 60,000 jobs a month, he said.
Given that figures published so far show that the economy has added about 40,000 jobs a month since April, the real number for 2025 could be something more like a loss of 20,000 jobs a month, Powell said.
“We think there’s an overstatement in these numbers,” Powell said.
Looking ahead to 2026 at the Fed
“Part of the committee would prefer to be more cautious. They want to see more data on inflation, more data on the labor market,” Marco Casiraghi, a senior economist at Evercore ISI, told Bloomberg Dec. 12.
With a new Fed chair coming in and expected to push for lower rates, “it’s going to be a bit of a bargaining process over how many cuts might be reasonable in 2026,” he said.
According to Bloomberg, Federal Reserve Bank of Cleveland President Beth Hammack said Dec. 12 she would prefer interest rates to be slightly more restrictive to keep putting pressure on inflation, which is still running too high.
“Right now, we’ve got policy that’s right around neutral,” Hammack said.
“I would prefer to be on a slightly more restrictive stance to help continue to put pressure” on the inflation side of the central bank’s mandate, she said.
Hammack will rotate onto the FOMC next year as a voting member, while Goolsbee will rotate off.
Markets brace for Trump’s decision on Powell’s replacement
The independence of the U.S. central bank is a key concern of global markets.
President Donald Trump’s thinly veiled threats to nominate an ally who will void the Fed’s data-driven history in favor of following his demands to slash interest-rates as low as 2% is a pressure point for investors.
Trump has repeatedly criticized Powell personally and professionally for not cutting interest rates more aggressively this year and signaled that his successor should push for rate cuts.
The White House has said it will announce a nominee in early January, setting off what will surely be a contentious Senate confirmation process.
Trump loyalist Kevin Hassett, director of the White House National Economic Council, is reported to be the frontrunner, but other contenders include Fed Governor Christopher Waller and former Fed Governor Kevin Warsh.
Hassett has said if he becomes the next Fed chair, he would rely on economic data to guide monetary policy decisions, not political whims.
Sen. Elizabeth Warren called Trump’s top contenders “sock puppets” in a Dec. 11 interview with CNBC.
She also singled out Hassett, saying he would not be able to maintain the Fed’s independence.
Warren is the top Democrat on the Senate Banking Committee, which is responsible for vetting nominees to the Fed’s board.
“The president is looking for someone who will do his bidding,” Warren said.
Related: Fed considers bold change to nation’s banking services
