This commentary follows the FOMC's update and is the opinion of TreasurySpring's capital market experts, Henry Adams and Nigel Owen, and does not constitute legal, investment, or other advice.
Unemployment was lower than expected in December after a spike in November, although given that covered some of the shutdown, it wasn’t 100% trusted by the market. (TradingEconomics) Non-farm payrolls were lower than expected in December and October and November’s numbers have also been revised down (TradingEconomics).
Meanwhile inflation fell to 2.7% in November, core inflation to 2.6%, and both remained there in December. The Fed’s preferred measure, the Core PCE Index, caught up after the shutdown, releasing October and November’s data on the same day. It dipped to 2.7% in October, then returned to 2.8% in November, as expected. (TradingEconomics)
So the overall trend for inflation remains downward, but getting close to the Fed’s 2.0% target is still appears to be proving a big ask, and so, with the labour market stabilising somewhat, it is probably wrestling back priority in the minds of many Fed members in our opinion.
The two who voted for the cut, Stephen Miran and Christopher Waller, were no real surprise. We don’t see them changing their view until a new Fed Governor is in charge. So if we are looking to read anything into the voting patterns, we should focus on the other 10 members. On this occasion they were unanimous, which is reassuring to see.
The recent strong GDP print was referenced, which we see as important: need to pause, let that play through for a few months, and, as Jay Powell has always said, be guided by the data.
As we can see from this chart showing the market’s implied Fed rates before and after the meeting, the market has come round to the Fed view of just one cut this year, with July the current meeting the market is focused on.
To date it looks to us like the Fed is continuing to largely ignore the inflation half of its mandate. We would certainly be holding as long as the market is implying, maybe even longer if inflation continues to remain stubborn. But in recent times, we have seen what seems to be an acceptance that inflation is what it is and more attention is being paid to the labour market. Can it continue to ignore it if inflation were to rise again to, say 3%?
As results season rolls through, it will be interesting to see if comments are made on whether the effects of last April’s tariffs are fully priced into US goods now or if there is more to come if US firms are to maintain margins. That could be an important factor in inflation from here.
And the other factor which we are yet to fully understand is how the bumper GDP growth of 4.4% in Q3 2025, the highest in two years, is feeding into either side of the mandate. In our opinion, it will be important to wait and see what effect it has on the data. Will it mean prices continue to rise with consumers presumably capable of absorbing them? And does it mean the fears about the labour market were overblown and the strength of the economy will support it?
There are many big unanswered questions, so the data needs watching closely to see if it gives any clues to those answers.
The absence of data due to the Government shutdown made this a difficult meeting to unpack. Jobs data has been reasonably robust, inflation remains fairly sticky, but a pivot in market expectations of a cut came when New York Fed President John Williams said in a speech he saw “room for a further adjustment in the near term to the target range for the federal funds rate”.
But an extra dissenter on the side of no cut suggests some policymakers may believe the Fed is at or close to the neutral rate, where it's no longer acting to stimulate or contract economic action.
The recent sell-off of the dollar against most major currencies does make US exports more favourable and that would make sense when put alongside the other policies we’ve seen from this administration. The other side of that coin is that it will make imports, already bearing increased tariffs, more expensive too.
Could it help US companies producing goods in the US and selling both at home and abroad? Absolutely. They will be more competitive in most of their markets. However, if those goods require imported parts, that competitiveness will be reduced, as the cost to build them goes up, pushing prices up… unless margins are going to be eroded.
So it feels to us to be inflationary for the US overall, which brings us back to what we talked about earlier. If inflation were to bounce up to 3%, can the Fed afford to keep ignoring it? In our opinion, it shouldn’t, and we could see the date of that next cut pushed back into Q4 if the dollar does continue to depreciate.
The market is pricing in just 15-16% chance of a cut and we would be hugely surprised if expectation shifts too much in the next seven weeks. But in that period, we will get two months worth of many economic measures. So if inflation were to relent and head back towards 2% alongside the labour market suddenly lurching for the worse, we think that 16% could push as high as 40%, maybe even 50%, if the data truly paints a struggling economy.
But we would be surprised if a move like that isn’t accompanied by a shift in the rhetoric from Fed Governors when they speak, so it will be widely flagged before it moves as far as 25-30%.
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