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The Federal Reserve's own signal raised the bar for further interest rate cuts next year, suggesting markets should expect restraint.
The Federal Reserve’s own signal that policy is now near neutral has raised the bar for further rate cuts next year, suggesting markets should expect restraint rather than rescue, setting the stage for fixed income, not aggressive easing, to do most of the heavy lifting in portfolios unless a recession emerges.
The Fed’s 25 basis point cut at the December meeting - the third this year- pushed rates to levels policymakers now view as close to neutral, a setting that neither stimulates nor restrains economic growth. With policy now within a “broad range of estimates of its neutral value,” Fed Chair Jerome Powell said the central bank is “well positioned to wait and see how the economy evolves.”
Periods when policy is close to neutral typically demand a unified Federal Open Market Committee, as missteps in either direction can carry outsized consequences. Cutting too far risks reigniting inflation, particularly as many expect fiscal policy to turn more expansionary next year under President Donald Trump.
Yet the latest meeting underscored growing divisions among Fed officials, raising questions about the confidence policymakers have in their own outlook. The Fed’s updated Summary of Economic Projections sketches a smooth path ahead: growth holding above 2%, a steady labor market, and inflation gradually returning toward target.
"On paper, that sounds terrific," Jim Baird, chief investment officer with Plante Moran Financial Advisors, told Investing.com’s Yasin Ebrahim in an interview. "The reality is achieving that will be much more difficult. You have to take these projections with a grain of salt,” he added.
Markets have taken Powell’s tone as a signal that further easing remains likely, pricing in as many as two rate cuts next year, according to Investing.com’s Fed Rate Monitor Tool. Fed officials, by contrast, continue to project just one despite the visible lack of consensus within the committee.
But whether it’s one cut, two cuts, or no cuts… the "core message there is: Don’t expect the Fed to do a lot more in the absence of a recession," Baird said.
Wall Street itself is far from unified on what comes next. Macquarie’s baseline is that the December Fed rate cut could mark the final move of the current easing phase, with its next policy shift eventually turning back toward tightening. Morgan Stanley, by contrast, expects the labor market to remain soft until tariff pass-through is complete and looks for additional cuts as soon as January and April, while flagging that if employment data hold up, further easing would likely require a clearer downshift in inflation.
With policy near neutral and valuations stretched in parts of the equity market, particularly among high-flying AI-linked stocks, fixed income appears poised to play a more central role in portfolios.
“For investors who should have a healthy allocation to fixed income, it’s their fixed income portfolio that’s able to do more of the heavy lifting,” Baird said, while cautioning that selectivity matters.
“Credit is still priced pretty aggressively in some areas,” he added. “I’d wait for a better opportunity to tiptoe in.”
As the neutral rate comes into focus, another risk looms: that the Fed may eventually be forced to pivot away from easing altogether.
“If the economy really takes off, inflation edges higher, and the Fed has to reverse course and tighten instead of cutting,” Baird said, “that would catch the market off guard.”