Fed's Internal Divisions Set to Carry Into 2026 Rate Debate
The 9-3 December vote split signals ongoing disagreement among FOMC members about how fast to cut rates, with the dot plot projecting just one reduction next year.
The Federal Reserve cut rates again in December. But the vote wasn't close to unanimous—and that division is expected to define 2026.
The FOMC reduced its benchmark rate by 25 basis points to a range of 3.50%-3.75% in a 9-3 split decision. Stephen Miran preferred a larger half-point cut. Austan Goolsbee and Jeffrey Schmid wanted no cut at all. That three-way disagreement—more aggressive, hold steady, or somewhere in between—captures the policy tension that will shape the year ahead.
Where Rates Stand
The December cut brought total easing since September 2024 to 175 basis points. The Fed's key overnight rate has dropped from 5.25%-5.50% to its current level, the lowest since 2022.
Chair Jerome Powell characterized the positioning as comfortable. "We are well positioned to wait and see how the economy evolves," he said at the post-meeting press conference. The statement acknowledged that inflation "remains somewhat elevated" while noting that economic uncertainty "remains elevated" as well.
The hedged language reflects genuine uncertainty. Inflation has moved up since earlier in 2025, complicating the case for continued cuts. But the labor market, while still solid, has shown signs of cooling that concern some officials.
The Dot Plot
The quarterly Summary of Economic Projections—the "dot plot" of individual rate expectations—painted a cautious picture.
FOMC members now project just one 25 basis point cut in 2026 and another in 2027 before reaching a longer-run target around 3%. That's a significant pullback from earlier 2025 projections that envisioned two or three cuts next year.
The shift reflects both realized progress and remaining concerns. With inflation still above the 2% target and the economy growing faster than expected—third-quarter GDP came in at an annualized 4.3%—officials see less urgency to ease further.
Market pricing has adjusted accordingly. Fed funds futures now imply roughly one or two quarter-point reductions in 2026, down from three or more that traders expected earlier this year.
Why the Disagreement
The 9-3 vote exposed three distinct views within the FOMC.
Miran's push for a larger cut represents the dovish camp worried about overtightening. With real rates still elevated relative to neutral estimates, this faction argues that failing to ease quickly enough risks unnecessary damage to employment.
Goolsbee and Schmid's preference to hold reflects the opposite concern. With inflation proving stickier than expected and economic growth exceeding forecasts, the hawkish argument is that further cuts risk reigniting price pressures.
The majority landed in between—cutting modestly while signaling patience. Powell's comments suggested this middle ground will anchor 2026 policy, with the Fed waiting for clearer signals before committing to additional reductions.
Economic Context
The economy has defied recession predictions.
Third-quarter GDP growth of 4.3% was the strongest reading since early 2024. Consumer spending remained robust through the holiday season, with retail sales up 4.2% according to Visa data. The unemployment rate, while edging higher, remains historically low at 4.1%.
That resilience creates a policy dilemma. If the economy doesn't need lower rates, cutting anyway risks inflation. But if growth eventually slows, having rates too high could deepen the downturn.
The Fed is navigating between those scenarios with limited visibility. Powell acknowledged as much, noting that policy decisions will remain data-dependent rather than following a preset path.
What Traders Are Watching
Bond markets have taken the Fed's caution to heart.
The 10-year Treasury yield hasn't fallen much despite three rate cuts in 2025, reflecting expectations that the easing cycle may be nearing its end. Yield curve dynamics suggest traders see limited room for further short-term rate reductions.
For equity investors, the implications are mixed. Slower rate cuts mean higher discount rates for future earnings, a headwind for growth stocks. But they also signal Fed confidence in economic durability, a tailwind for cyclicals and value names.
The VIX has drifted lower despite the policy uncertainty, suggesting markets have priced in a "higher for longer" baseline. Any deviation—whether unexpected cuts or a hawkish pivot—could trigger volatility.
2026 Outlook
The Fed's next scheduled meeting is January 28-29. Markets expect no change, with the first potential cut of 2026 not priced in until mid-year at the earliest.
Between now and then, officials will scrutinize inflation readings, employment data, and any signs that the economy's momentum is fading. The December projections aren't a commitment—they're a forecast that will evolve with incoming information.
For traders, that means watching the data more than the Fed. With policy on hold, economic releases will drive rate expectations. A hot inflation print could push cut expectations further out; a weak jobs report could pull them forward.
The Fed's divisions aren't going away. If anything, they'll intensify as officials debate the appropriate response to whatever 2026 brings.