Assessing Fed Rate-Cut Odds Amid Stable Core CPI Inflation and Market Volatility

The Federal Reserve's path in 2026 remains a balancing act between inflation normalization and political uncertainty, with implications for equity and bond investors. Recent data and projections suggest a cautious approach to rate cuts, even as inflation stabilizes near 2.7% and economic growth remains resilient. Strategic positioning for investors must account for both the Fed's data-dependent stance and the broader macroeconomic and political risks shaping the landscape.

Stable Inflation and the Fed's Gradual Path

The U.S. core CPI inflation rate held steady at 2.7% in December 2025, consistent with expectations and reflecting a gradual easing of price pressures despite lingering stickiness in sectors like shelter and labor costs. The Federal Reserve's December 2025 projections anticipate core PCE inflation declining to 2.5% in 2026, with a longer-term target of 2.0%. While inflation remains above the 2% goal, the Fed's December rate cut and its January 2026 decision to maintain the federal funds rate in the 3.50%-3.75% range signal a measured approach to normalization.

The Fed's December 2025 Summary of Economic Projections underscores a median forecast for one 25-basis-point cut in 2026, contingent on economic data. However, internal dissent at the December meeting- three members favored no cuts-highlights the committee's divided stance. The labor market's resilience, with unemployment projected to fall to 4.4% in 2026, further complicates the case for aggressive easing.

Political Uncertainty and Policy Risks

Political developments in 2026 add another layer of complexity. The potential appointment of a new Fed Chair under President Donald Trump and the influence of hawkish regional bank presidents on the FOMC could shift policy priorities. Goldman Sachs projects two rate cuts in 2026, but these are contingent on inflation staying near 3% and growth remaining robust. Deutsche Bank's Matthew Luzzetti argues that solid economic performance may limit the Fed's appetite for cuts, particularly if inflationary pressures persist.

The Pinebridge Investment Strategy report notes that the fed funds rate remains above the neutral level, but further cuts will depend on labor market softening and sustained inflation containment. Political risks, including potential Supreme Court rulings that could redefine the Fed's independence, add uncertainty to the policy trajectory.

Strategic Positioning for Equities and Bonds

For equity investors, the dominance of AI-driven growth remains a key theme. AI is reshaping corporate earnings and sector dynamics, particularly in technology, where winner/loser differentiation will intensify. A constructive scenario assumes inflation remains tame enough to allow continued Fed easing, supporting risk assets. However, risks include inflation flare-ups or a slowdown in AI adoption, which could trigger profit-taking and volatility. Emerging market equities may benefit from stable financials and AI-related sectors but remain dependent on earnings resilience.

In fixed income, the focus is on the AI and capital expenditure (capex) cycle, which is driving heavy debt issuance. Investors should avoid opposing this issuance wave, as spreads could tighten if new paper is absorbed by yield-hungry buyers. However, if investors perceive deals as equity-like in risk-return profiles, spreads may widen. The Lord Abbett report highlights that easing global financial conditions and cautious optimism about corporate fundamentals create a supportive backdrop for bonds.

Navigating the Uncertain Outlook

Investors must remain agile, balancing exposure to AI-driven growth with hedging against macroeconomic and political volatility. For equities, sector rotation toward AI beneficiaries and defensive financials could offer diversification. In bonds, a focus on high-quality investment-grade issuance tied to the AI capex cycle may provide stability.

The Fed's data-dependent approach and political uncertainties mean that rate-cut timelines remain fluid. As the Fed navigates inflation normalization and potential policy shifts, investors should prioritize flexibility and scenario planning.