The Federal Reserve cut interest rates by a ¼-point yesterday, as expected. The stock market rallied, and Treasury yields fell. But the cut is considered “hawkish” because the central bank remained vague about the prospects for more policy easing in the near term.

Fed Chair Jerome Powell suggested the central bank would stay cautious on whether to cut further. “We’re well positioned to wait and see how the economy evolves,” he said.

Reviewing the Fed’s newly updated dot plot – a summary of members’ expectations for interest rates – points to one rate cut for 2026, unchanged from the previous update in September. An added source of uncertainty: the outlook for rates next year is relatively wide ranging among the 19 FOMC members.
 

Yesterday’s rate cut for a ¼ point was also accompanied by three dissenters at the Fed, who advocated for no change – an unusual split vs. recent history that skewed closer to unanimous decisions.

Perhaps one reason for reserving judgment by some members on recommending more cuts: New Federal Reserve economic projections reflect modestly higher growth and lower inflation forecasts. If correct, there’s a case for pausing with more policy easing. GDP growth in 2026 is expected to increase 2.3%, up from 1.8% in the September estimate, according to the revised Fed outlook. Meanwhile, PCE inflation at the headline level is projected to ease to 2.4% next year from 2.6% in the previous estimate.

The labor market, however, is motivating concerns that the economy will continue to weaken, which implies more rate cuts are reasonable. Several private sources recently reported that payrolls have been contracting lately (see ADP’s November estimate, for instance), while nowcasts for the Q4 GDP point to a significant slowdown in growth.

Playing into these concerns, Fed Chair Powell yesterday said official US data could said be overstating job creation by up to 60,000 jobs a month. Recent numbers show the economy has added about 40,000 jobs a month since April, but the actual number could be closer to losing 20,000 jobs a month, according to analysis by the Fed, he noted.

Another possible complication for markets in the year ahead is growing divergence between long and shorter-term Treasury yields, which some analysts suggest could be problematic. For example, Apollo’s chief economist Torsten Slok this week asked:

Why are long-term interest rates going up when the Fed is cutting rates, see the first chart? Is the market worried about growing Treasury issuance, or about a new Fed leadership effectively raising the inflation target from 2% to, say, 4%? This pattern of rising long-term interest rates is highly unusual when we look at the historical reaction during Fed cutting cycles.

I’m not yet convinced that there’s an anomaly unfolding. Consider how the spread for the 30-year yield less its 10-year counterpart have evolved over the past 25 years across four rate-cutting cycles.
 

To my eye, in all four cases, the 30-year/10-year spread rose as the Fed cut its target rate. By that standard, the rise in the spread lately is echoing previous rate-cutting cycles.

But Slok is persuaded otherwise, advising: “The reality is that about a year ago, long-term interest rates started drifting higher than what would have been predicted by short-term interest rates and oil prices.” He concludes: “The bottom line is that the yield curve continues to steepen, and investors across all asset classes need to think about why.”

Another risk factor that should concentrate minds is the rise in federal debt, which suggests that the increase in long-term rates is driven by more than cyclical factors this time.

“The American government budget is not on a sustainable path,” observes Joseph Brusuelas, chief economist of RSM US. “The price of money in global markets will be affected by the trajectory of the US borrowing, which as it increases will raise financing costs for American households and businesses.”

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