Xiao Cui, Senior Economist Pictet Asset Management.
We continue to expect the FOMC to cut rates by 25bps at its meeting next week. A hold is a non-negligible hawkish risk, but will likely only come after some well-placed weekend news article(s). The market-implied probability of a cut sits just below 100%, after dipping to as low as 35% two weeks ago. Based on pre-blackout Fedspeak, the 12 voting members are fairly divided on cutting versus holding rates steady. We expect Chair Powell to lean into the downside risk to the labor market and push through another cut to end the year. There will likely be at least two hawkish dissents from regional Fed presidents. Governor Miran may dissent in favor of a 50bps cut, but he has indicated that if he were the marginal vote he will support a 25bps cut.
The limited data released since the last FOMC meeting suggest the labor market remains in a low-hiring, low-firing mode, with a small pickup in layoff announcements but still-low levels of actual jobless claims. Inflation remains above target and is likely rising, but ex-tariffs sits closer to the Fed’s target.
In our base case of a 25bps cut, we expect hawkish forward guidance. Powell will likely note that as rates inch closer to neutral, the FOMC can take a more cautious and measured approach and, going forward, policy will be set on a meeting-by-meeting basis. The 2026 interest rate projections are widely dispersed, with a fragile median at 3.375%, suggesting one rate cut in 2026 after a December cut, way more hawkish than current market pricing. We expect the median to remain at one cut, with a hawkish risk that the median shows no cut at all next year. With inflation sticky above target, many regional Fed presidents have little appetite for lower rates.
Chair Powell could update the Fed’s plans to grow reserve balances, which have fallen further toward the ample level since the October FOMC meeting, though we think a formal annoncement is more likely in Q1. The Fed will likely need to regrow the balance sheet by starting reserve-management purchases of T-bills soon to prevent funding market pressures. This could be seen as “technical QE,” but it is not QE, as it neither removes duration risk from the market nor aims to signal an accommodative policy stance.
We expect solid growth, above-target inflation, and a slowing labor market to increase internal divisions at the FOMC and make 2026 a particularly challenging year for policymakers. Downside risks to the labor market should lead the Committee to cut once more in December, before shifting to a quarterly pace of cuts in March and June to reach a terminal rate of 3.0%–3.25%. We see risks that Fed cuts are delayed into the second half of 2026.
The 2026 interest rate projections are widely dispersed, with a fragile median at 3.375%
