The Fed Might Not Be Done Cutting Rates. The Labor Market Is a Factor.

Fed Chair Jerome Powell during a news conference following a Federal Open Market Committee meeting in Washington, D.C., on Thursday.. (Al Drago/Bloomberg)

Key Points

• The Federal Reserve reduced interest rates by a quarter percentage point to a range of 3.50%-3.75%, marking the third cut in four months.
• Despite the recent cut, the Fed’s economic projections for 2026 indicate only one additional rate reduction, contrasting with market expectations of two cuts.
• The decision revealed division among policymakers, with nine supporting the cut, two preferring to hold, and one advocating for a larger half-point reduction.

The Federal Reserve lowered interest rates for the third time in four months on Wednesday while signaling that further easing is far from assured.

The move highlighted a tension that will define policy in the months ahead: whether officials continue cutting rates to support a cooling labor market or hold steady out of concern that inflation remains above the Fed’s 2% target. How the Fed balances those competing risks will become a central question at its next meeting in January and throughout 2026.

Despite Wednesday’s quarter-point interest rate cut to a range of 3.50%-3.75%, the central bank’s latest economic projections show only one additional reduction next year, unchanged from September. Markets, by contrast, continue to price in just over two cuts in 2026, reflecting investors’ expectations that labor-market softness will ultimately outweigh lingering inflation pressures.

Fed officials, however, upgraded their 2026 growth forecast to 2.3% from 1.8% in September, lowered inflation projections, and kept unemployment expectations broadly steady, a combination that suggests they see less urgency to ease further unless conditions deteriorate.

The December decision also revealed unusual division among policymakers. Nine officials supported the cut, two preferred to hold rates steady, and one favored a larger half-point move.

Chair Jerome Powell said monetary policy is now “within a broad range of estimates of neutral” and that officials are “well-positioned to wait and see how the economy evolves.” Asked whether rate increases remained possible, he said, “I don’t think that a rate hike is anybody’s base case at this point.”

Powell framed the latest move as a response to shifting labor-market risks. “Downside risks to employment have increased in recent months,” he said. Job gains have slowed and companies have announced layoffs even as unemployment insurance claims remain low, adding uncertainty to the outlook, he noted.

On inflation, Powell described tariff-related price increases as temporary. Inflation excluding tariffs is close to the Fed’s 2% goal, he said, calling the tariff-driven rise “a one-time price increase.” The Fed’s own forecast supported that view, officials expect overall inflation to ease over the next two years and revised their 2026 projections lower.

Still, some analysts argue that weakening labor-market data will eventually force the Fed to move sooner and more decisively.

“We expect weaker labor market data to lead to 25 basis points rate cuts in January and March and think markets are underpricing risks skewed toward deeper cuts next year,” analysts at Citigroup wrote Wednesday afternoon. Twenty-five basis points is equivalent to a quarter percentage point.

Others caution that uncertainty inside the Fed itself may slow the pace of change. Rick Rieder, BlackRock’s chief investment officer of global fixed income and a potential replacement for Powell when his term expires in May, noted the divided vote in his outlook.

“Given the lack of consensus on the Committee displayed today, along with the slow release of traditional economic data, and the arrival of a new Fed Chair early in 2026, we think the Fed is likely to remain on hold for a while,” he wrote. “Still, continued softness in some of the labor indicators can certainly bring another [quarter point] cut into the mix for January.”

Powell emphasized Wednesday that the effects of the past three cuts “are only beginning” to be felt and said more complete data, available once federal statistics return to normal reporting schedules following the government shutdown, will paint a clearer picture of how recent policy moves are filtering through the economy. “We’re going to get a great deal of data between now and the January meeting,” he said. “That will factor into our thinking.”

The central bank also said it would begin purchasing Treasury bills to maintain ample reserves, a technical step Powell emphasized was unrelated to quantitative easing.

The Fed’s position could soon be shaped by political considerations as well. Powell’s term as chair ends in May, and President Donald Trump is currently interviewing potential successors. The announcement of the next Fed chair is expected in early January.

The president said Wednesday that the Fed could have “at least doubled” the size of its latest cut, adding new pressure when officials are attempting to reinforce their message of patience.

Asked about his legacy on Wednesday, Powell said he hoped to be remembered for guiding policy through an unusually challenging period. “I really want to turn this job over to whoever replaces me with the economy in really good shape,” he said.

The Federal Reserve next meets on Jan. 27-28.

Write to Nicole Goodkind at nicole.goodkind@barrons.com.