With Fed Set to Meet Next Week, December's Rate Cut Now Looks Questionable

Why It Matters

The mis‑timing of the December cut could leave the Fed with an ill‑suited policy stance, forcing a quicker reversal that may tighten financial conditions and affect growth outlooks.

Key Takeaways

• Core PCE inflation rose to 4.1% YoY by early 2026.
• Overall PCE inflation hit 5.5% YoY, driven by energy prices.
• Unemployment steady at 4.3% while job gains average 114k/month.
• Only two hawkish dissenters voted against the Dec rate cut.
• Governor Waller now favors steady rates, may raise if inflation spikes.

Pulse Analysis

The Federal Reserve’s December 2025 decision to cut rates for the third time in a row now appears misaligned with the macro backdrop. Core personal consumption expenditures (PCE) inflation, the Fed’s preferred gauge, has surged from a projected 2.5% to 4.1% year‑over‑year, while headline PCE sits at 5.5% due largely to an energy price spike linked to the Iran conflict. At the same time, the labor market has defied expectations, holding unemployment at 4.3% and delivering roughly 114,000 jobs each month, a stark contrast to the flat job growth seen in 2025. This combination of persistent price pressures and robust employment creates a policy conundrum for the incoming chair, Kevin Warsh, who must decide whether to sustain the dovish trajectory or begin a pre‑emptive tightening to anchor inflation expectations.

Market participants are already pricing in a heightened probability of a rate hike later in 2026, reflecting concerns that the December cut may have been a Pyrrhic victory for the doves. The Fed’s internal split is evident: only two members—Jeff Schmid of Kansas City and Austan Goolsbee of Chicago—registered hawkish dissent, while the majority rallied behind the cut. Governor Christopher Waller’s recent remarks underscore the shift; he now emphasizes inflation as the primary driver of policy and signals readiness to raise rates if expectations become unanchored. This evolving stance is likely to influence Treasury yields, corporate borrowing costs, and equity valuations as investors recalibrate risk premia.

Beyond the immediate policy debate, the episode highlights the lagged and uncertain impact of monetary adjustments. Over‑easing can embed inflationary momentum, while delayed tightening risks overshooting the neutral rate, potentially stalling growth. Businesses should monitor Fed communications closely, especially any signals about the neutral rate’s new placement, as well as real‑time inflation data. Companies with price‑sensitive margins may need to hedge against higher financing costs, while sectors reliant on cheap credit could face tighter conditions if the Fed pivots toward a more neutral or restrictive stance.