Fed to Trim Rates 25BP as Inflation Eases, Yields Defy Expectations

The U.S. Federal Reserve is expected to cut interest rates by 25 basis points at its December 11 meeting, as soft inflation data and mixed labor market signals reinforce the case for a reduction in borrowing costs. Recent releases show core Personal Consumption Expenditures (PCE) inflation at 2.8% year-on-year, a level consistent with the central bank's long-term target. Investors and economists are now pricing in an 87% chance of a rate cut to 3.50%-3.75% according to market analysis.

Market participants have been closely watching for signs of a turning point in the Fed's tightening cycle. The central bank has already cut rates twice this year, including a 25-basis point reduction at its October meeting. The latest data, including a weak core PCE print, has reduced concerns about inflationary momentum and raised hopes that the Fed may continue its easing path.

However, the path forward is not without uncertainty. While the rate cut at this meeting is expected, Fed Chair Jerome Powell has hinted that the bar for further reductions is likely to rise. The central bank will need to see more consistent evidence of cooling inflation and a stable labor market before committing to another round of easing.

Market Reactions to the Outlook

U.S. equities have responded positively to the improved rate cut odds, with the Nasdaq 100 rising 1% for the week and the S&P 500 up 0.31%. These gains reflect investor optimism that lower interest rates could support economic growth and corporate earnings. Meanwhile, Treasury yields have moved in an unexpected direction. Despite the softer inflation data, 10-year yields rose 12 basis points for the week, the largest increase since April.

The yield rise was partly attributed to a stronger-than-expected Canadian jobs report and a general reflationary trend in global bond markets. A breakout above the 4.17%–4.19% level for U.S. 10-year yields could open the door to further gains, potentially reaching 4.50% by early 2026. This would test the resilience of equity markets and raise borrowing costs for businesses and consumers.

Analysts and Policy Implications

Analysts are watching closely for clues about the Fed's future policy stance. Rabobank expects the FOMC to cut rates to 3.50%-3.75% and anticipates that dissenters may emerge, reflecting the central bank's internal debate over the inflation-employment trade-off. At his upcoming press conference, Powell is likely to emphasize data dependence, reinforcing the idea that future decisions will be made on a meeting-by-meeting basis.

The market is already pricing in two additional 25-basis point cuts in 2026, with a 50% probability of a third cut by year-end. However, this expectation could shift depending on how the Fed communicates its inflation outlook and the broader economic environment. The central bank's dot plot, which reflects policymakers' individual forecasts, may not fully account for the potential influence of the incoming Trump administration, according to Rabobank according to Rabobank analysis.

Risks to the Outlook

One key risk to the rate-cut narrative is the uncertainty surrounding the next Fed chair. With Kevin Hassett emerging as a potential nominee, investors are growing nervous about the central bank's independence. Hassett, a Trump ally, has voiced strong support for aggressive rate cuts, raising concerns that policy could be driven by political pressures rather than economic fundamentals.

The bond market has already reacted to these concerns, with 10-year Treasury yields rising after Hassett's nomination odds increased. Analysts suggest that investors are bracing for the possibility of a return to higher inflation and potential rate hikes down the line if the Fed becomes too accommodative. This dynamic adds a layer of volatility to the current easing narrative.

Another challenge lies in the global economic landscape. China has pledged to adopt a more proactive fiscal and monetary policy in 2026, including potential rate cuts and increased government spending. While these measures could support global growth, they also add to the uncertainty surrounding inflation and trade dynamics. For now, the focus remains on the Fed's decision and its broader implications for global financial markets.

What This Means for Investors

Investors are advised to remain cautious given the evolving policy environment. The current optimism about rate cuts is supported by improving inflation data and weaker labor market signals, but the path ahead is subject to change based on economic surprises and geopolitical shifts. Portfolio managers are monitoring the JOLTS report and other labor indicators ahead of the FOMC decision.

In the short term, the equity market is likely to remain range-bound as investors await the Fed's official statement and Powell's press conference. Longer-term, the market is factoring in a gradual easing cycle that could support risk assets in early 2026. However, rising bond yields and the potential for a Trump-aligned Fed chair introduce elements of uncertainty that may require a more defensive stance.