The Federal Reserve has now cut interest rates three meetings in a row. At first glance, that looks like a central bank easing confidently into 2026. Look again. Beneath the headline 25bp cut to 3.5–3.75 per cent lies a more awkward message: the Fed is not preparing for a return to the era of low rates. It is preparing markets for the opposite.
The split vote — 9 in favour, 3 dissenting — exposed a committee moving in different directions at once. Stephen Miran, appointed under Donald Trump, wanted an even deeper cut. Two officials preferred no move at all. The dots deepen the divergence: for 2026, half the committee sees no rate cuts; the other half sees two or more. Markets, desperate for clarity, received none.
Yet investors seized on what was absent rather than what was present. No hawkish bloc formed. No dissenting coalition materialised. Instead, equities jumped, Treasury yields tumbled and traders declared a dovish victory. Futures markets now assume the Fed is content to let the economy run warm, even as Chair Jay Powell insists policy remains “data dependent”.
The market’s enthusiasm looks premature
The Fed held its longer-run neutral rate at 3 per cent, a level well above the pre-pandemic norm and one increasingly supported by structural forces. Persistent fiscal deficits, reshoring-related investment, stronger nominal growth, and demographic tightness all point to an economy that can tolerate (and may require) firmer policy to contain inflation. Some analysts think the true neutral rate is higher still.
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The Fed’s own projections align with that worldview. Growth in 2026 has been revised up to 2.3 per cent. Inflation edges down only slowly. Unemployment drifts higher, but not to levels that would decisively cool demand. In other words, the central bank is cutting now but preparing for a world in which rates remain structurally elevated.
Markets briefly behaved as though the Fed had turned dovish wholesale. Then reality set in. Major US equity indices have already surrendered their post-meeting gains. Gold, which should have benefited from lower yields, has remained stuck around $4,200, unimpressed. The dollar and longer-dated yields remain weak. Such cross-market hesitancy reflects a nagging concern that the Fed is underestimating inflation risk, or overestimating its tolerance for economic overheating.
QE adjacent monetary policy
The Fed did offer one genuine surprise: an unexpected return, in miniature, to balance-sheet expansion. After shrinking by $2.4tn since 2022, the balance sheet will rise again through purchases of short-term Treasuries, as the Fed attempts to mop up signs of reserve scarcity revealed by rising usage of its repo facility. This is not QE in the pre-2022 sense — the Fed is not trying to suppress term premiums — but it is QE-adjacent. For equity bulls, that alone often suffices.
Indeed, the Russell 2000 promptly hit record highs, fuelled by fresh liquidity and hopes of an easier credit backdrop. Commodities rose on the combination of lower rates and stronger growth projections. The yield curve bull-steepened, signalling renewed expectations of an accommodative Fed.
Investors may wish to temper the holiday cheer
The Fed’s dot plot shows only one cut next year. Powell described an economy not yet showing signs of distress. Inflation remains at 3 per cent and could face tariff-related pressure. If the Fed is indeed allowing the economy to run hot, it is doing so only at the margins, and only while inflation behaves.
The final meeting of 2025 delivered a cut without capitulation, QE-lite without euphoria, and projections that confirm a higher-for-longer world. Santa may deliver a rally. But 2026 could yet deliver a reckoning.
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