Chief Global Strategist
On Wednesday, the Fed will hold its last FOMC meeting of the year. Their actions and communications could move interest rates across the yield curve and so are important for investors.
In the six weeks since the last FOMC meeting, expectations on this week’s decision have swung wildly. On October 30th, the day after that last meeting, futures markets had priced in a 73% probability of a December cut. However, in the weeks that followed, a series of hawkish speeches and statements by FOMC members cast serious doubt on that thesis, with the probability of a December cut falling to just 30% by November 19th.
At that point, Fed leadership appeared to intervene. On November 21st, in a speech in Santiago, Chile, New York Fed President, John Williams, who also serves as Vice-Chairman of the FOMC, reviewed the outlook in a fairly balanced way but concluded by stating that “…I see room for a further adjustment in the near term to the target range for the federal funds rate to move the stance of policy closer to the range of neutral….” Markets immediately interpreted this sprightly prose as a signal that the most senior members of the FOMC favored a December cut and market odds of this occurring shot up to 71%. They have drifted higher since with an 86% probability of a cut being priced in as of Friday.
We expect that this rate cut will now occur. However, there is clearly a division within the Fed both on current economic prospects and the appropriate pace of further easing and, if the Fed does cut on Wednesday, there could be multiple dissents to that decision.
Casting a shadow over all of this is the unprecedented pressure being applied by the administration to get the Fed to cut rates. However, based on their recent speeches, the real division within the Fed is not one of politics but rather of forecasts, as they all try to discern the path forward in a particularly foggy economic landscape.
As part of their Wednesday communications, the Fed will release its summary of economic projections, or SEP, outlining the collective views of FOMC participants on growth, unemployment and inflation. It’s worth reviewing each of these, both to see how the numbers themselves might evolve and to consider how Fed thinking on the outlook might be evolving.
Growth
On economic growth, we believe real GDP rose at a roughly 2.5% annualized pace in the third quarter but may see zero growth in the fourth. This would equate to a 1.4% year-over-year real GDP gain in the fourth quarter.
We already know that real consumer spending rose at a healthy 2.7% pace in the third quarter. However, it appears to be growing more slowly in the fourth, since, despite solid early holiday season sales, light vehicle sales have fallen so far in the fourth quarter relative to the third. Tariff increases may be restraining inventory growth while federal government output in the fourth quarter has been dented by the government shutdown. Finally, although investment spending on data centers are receiving heavy publicity, less glamorous areas of capital spending, such as heavy truck sales, oil drilling and residential construction are lagging.
Looking forward to 2026, we expect the economy to ramp up to roughly 3% growth in the first half of the year, as consumer spending is powered by huge income tax refunds as well as recent wealth gains, and then sink back to 1% growth in the second half, leaving us with roughly 2% growth year-over-year by the fourth quarter. A sharp decline in immigration likely means that the working-age population is now falling so, unless we see further fiscal stimulus on the demand side and some unexpected surge in labor-force participation or productivity growth on the supply side, overall real GDP growth could slow to just 1.5% in 2027.
We expect the SEP to show a little more near-term optimism reflecting an Atlanta Fed expectation of 3.5% growth for the third quarter and positive holiday season sales reports. We also suspect that the Fed may be more sanguine about long-term growth prospects. In September the median projection called for 1.6% growth in 2025, 1.8% growth in 2026 and 1.9% growth in 2027. We expect to see very little change in these numbers on Wednesday.
Unemployment
On unemployment, the data remain very confusing.
Looking first at job growth, numbers through September look soft, with non-farm payrolls rising by an average of just 39,000 per month over the prior five months. Fourth-quarter job gains should be further depressed by a reduction in federal government employment, as employees who accepted buyout offers earlier in the year fall off federal payrolls. Meanwhile, a strongly negative estimate of the annual benchmark revision for March 2025 suggests that even the mediocre job gains that have been published may have overestimated reality. This benchmark revision will be incorporated in the January 2026 jobs report, due out in early February, giving us a clearer picture of recent job growth.
Fourth-quarter numbers from ADP show a very mediocre 47,000 gain in private payrolls in October being mostly offset by a 32,000 decline in November. Both the ISM manufacturing and services surveys showed continued job losses in November. While more Conference Board survey respondents reported jobs as being “plentiful” than “hard to get” in November, the gap between these two numbers was the second smallest in over four years.
There are still some positive signs. Low weekly initial claims for unemployment benefits suggest that companies are still reluctant to lay workers off while this week’s JOLTs report could continue to point to over seven million job openings as recently as late October. We increasingly appear to be in a low-hire, low-fire economy, as employers grapple with a chronic shortage of qualified workers for many positions.
That being said, while changes in labor supply should, in theory, limit any increase in the unemployment rate, it has crept up in recent months and stood at 4.4% in September, up from 4.1% a year earlier. We believe this could rise to 4.5% as a fourth quarter average. This should then stabilize in the first half of 2026 and drift back down to close to 4.0% in the second half in a delayed response to a first-half surge in economic activity. In 2027, if economic growth averages a sluggish 1.5%, then slow growth in labor demand could meet slow growth in labor supply, holding the unemployment rate at 4.0%.
We expect the SEP to show a 4Q2025 unemployment rate of 4.5%. However, in September, the SEP had unemployment falling only very slowly to 4.4% at the end of 2026 and 4.3% at the end of 2027. The committee may well maintain this forecast on Wednesday, providing a rationale for further Fed easing.
Inflation
Meanwhile, the most closely watched FOMC forecast on Wednesday concerns inflation.
The latest readings on both the consumer price index and the personal consumption deflator are from September. There will, effectively, be no good numbers on either of these indices for October since the government shutdown meant that source data were simply not collected. The November CPI will be released on December 18th, allowing analysts to try to piece together inflation trends over the fourth quarter.
While “affordability” is the current political watchword, inflation has only gradually increased in recent months, with CPI inflation rising from 2.3% year-over-year in April to 3.0% in September. Tariff increases are gradually feeding through, boosting core goods prices and consumers are experiencing rising costs for both electricity and natural gas.
However, elsewhere, inflation trends are generally benign. The price of a gallon of regular gasoline has now fallen below $3 nationwide, while fourth-quarter softness in light-vehicle sales and domestic tourism, is restraining inflation in the transportation and travel industries. The latest readings from Indeed and ADP suggest some softening in wage growth in the fourth quarter as the unemployment rate edges up. Finally, a surge in multi-family unit housing supply, coupled with lower immigration, is likely contributing to the rising rental vacancy rates and falling rents documented in the Apartment List National Rent Report.
Putting it all together, we now expect fourth-quarter year-over-year inflation of 3.4% as measured by CPI and 3.1% as measured by the consumption deflator. These numbers will likely both edge up somewhat in the first half of next year as a surge in income tax refunds allows retailers to pass on tariff increases to consumers. However, by the second half of 2026, assuming no further fiscal stimulus or tariff increases, inflation should drift down, with CPI inflation falling to just over 2% year-over-year by the fourth quarter and consumption deflator inflation falling to below 1.9%. If 2027 sees the slow economic growth we expect, consumption deflator inflation could remain below 2%.
In September, the median expectation among FOMC participants for year-over-year consumption deflator inflation was 3.0% for 4Q2025, 2.6% for 4Q2026 and 2.1% for 4Q2027. While they may make little change to this year’s number we expect that they will cut their projection of inflation for the end of next year, a crucial step in justifying further easing.
The Decision and its Consequences
The SEP also provides median estimates of long-run economic growth, the unemployment rate and consumption deflator inflation that participants expect to be achieved with appropriate monetary policy. In September, these numbers were 1.8%, 4.2% and 2.0% respectively and we don’t expect them to change this week.
Looking at probable SEP forecasts relative to these goals, it is hard to make the case for further easing. While growth, inflation and unemployment are all likely to fall in the second half of 2026, the economy looks set to spend much of next year with inflation exceeding its long-run optimal pace by considerably more than unemployment. While growth will likely slow in 2027, this is due to supply-side issues that the Fed has very little ability to impact. Meanwhile, lower interest rates threaten to fuel a further increase in already bubbly asset prices, adding to both economic risks and inequality.
This argument will likely be fully aired at this week’s FOMC meeting, with the four currently-voting regional Fed presidents potentially all arguing for no cut at this time. Despite this, we do expect a majority on the committee to approve a 25-basis point rate cut.
However, while we expect Stephen Miran to continue to dissent in favor of faster rate cuts, there could be three or four dissents in favor of no action. If this occurs, it should solidify market expectations that the Fed will wait at least until March before easing further. Indeed it is quite possible that, if income tax refunds do lead to stronger growth in the first half of 2026, the Fed might wait until later in the year to conduct any further easing. Still, based on our own forecast, we expect at least one rate cut at the end of 2026 in recognition of inflation finally falling below the Fed’s 2% target after exceeding it for more than five years.
For investors, given the certainty with which the December rate cut is being priced in, multiple dissents could represent a hawkish surprise, potentially boosting the short end of the yield curve and the dollar but potentially hurting stock prices that have steadily moved higher over the past three years on the prospect for an ever-easier Fed.