The Federal Reserve is poised to deliver its third and final rate cut of 2025, reducing the benchmark interest rate by 25 basis points to a range of 3.75% from 4.00%. This move, widely anticipated by financial markets, reflects the central bank’s ongoing efforts to support economic growth while keeping inflation under control. 

However, the focus is now shifting to the Fed’s outlook for 2026, as policymakers remain divided on the pace and extent of future rate adjustments. The updated “dot plot” projections, along with Chair Jerome Powell’s remarks, are expected to provide critical insights into the Fed’s strategy for the coming year.

Market Pricing and Expectations

How Markets Have Priced the Fed Rate Cut

Financial markets have already priced in the 25 basis point rate cut, with the CME FedWatch Tool assigning an 87.6% probability to this outcome. This high level of certainty has muted immediate market reactions, as investors have shifted their attention to the Federal Reserve’s forward guidance. 

The “dot plot,” which outlines policymakers’ expectations for future rate changes, is expected to signal a cautious approach for 2026. Current projections suggest only one or two rate cuts next year, reflecting the Fed’s intent to avoid aggressive easing that could reignite inflationary pressures.

The Role of Forward Guidance

Chair Powell’s press conference following the announcement will be critical in shaping market sentiment. Investors will be looking for clarity on whether the Fed plans to pause its rate-cutting cycle in early 2026. 

Powell is expected to strike a delicate balance, signaling that the Fed remains vigilant about inflation risks while acknowledging the need to support a slowing economy. The updated economic projections will also shed light on the Fed’s views on growth, inflation, and unemployment, providing a roadmap for monetary policy in the months ahead.

Labor Market Resilience

Insights from the JOLTS Report

The labor market continues to show resilience, as evidenced by the latest JOLTS (Job Openings and Labor Turnover Survey) report. Released yesterday, the report revealed 7.67 million job openings in October, significantly exceeding expectations of 7.14 million.

This robust demand for labor underscores the economy’s strength, even as other indicators suggest a gradual cooling. For instance, voluntary quits and hires have declined, while involuntary layoffs have increased, pointing to a more cautious hiring environment.

Implications for Monetary Policy

The unemployment rate, currently at 4.4%, and slowing wage growth are additional signs of a labor market that is losing some momentum. Wage growth, as measured by the Atlanta Fed’s wage tracker, has fallen from a peak of nearly 7% in 2022 to just above 4% this year. 

These trends provide the Federal Reserve with some justification for easing monetary policy, as they suggest that inflationary pressures from the labor market are diminishing. However, the strong job openings data complicates the Fed’s decision-making, as it highlights the economy’s underlying resilience.

Asset Class Reactions

Currency Markets and the Dollar Index

The dollar index (DXY) is expected to weaken slightly following the rate cut, as lower interest rates reduce the yield advantage of the U.S. dollar. This could provide a modest boost to major currency pairs such as EUR/USD and GBP/USD, which are likely to see gains as the dollar softens. 

On the other hand, USD/JPY may experience a decline, reflecting a stronger yen against a weaker dollar. Meanwhile, commodity-linked currencies like AUD/USD and NZD/USD could benefit from improved risk sentiment, as lower rates typically support global economic activity.

Gold and Commodities

Gold prices are consolidating near recent highs, with the potential for further gains as lower interest rates enhance the metal’s appeal as a non-yielding asset. A weaker dollar also makes gold more attractive to international buyers. In the energy markets, WTI crude oil prices are expected to remain stable, as the Fed’s decision is unlikely to have a direct impact on oil demand in the near term.

Equities and Cryptocurrencies

In the equities market, the Nasdaq is likely to see slight gains, driven by optimism in the tech sector, which tends to benefit from lower interest rates. The S&P 500 and Dow Jones, however, may exhibit mixed performance, as investors weigh the Fed’s dovish action against concerns about a potential “hawkish cut” signaling a pause in 2026. Cryptocurrencies, including Bitcoin, could experience increased bullish sentiment, as lower rates improve liquidity and risk appetite among investors.

The Dot Plot and 2026 Outlook

What the Dot Plot Reveals

The updated dot plot will be a key focus for investors, as it provides a window into the Federal Reserve’s internal deliberations. In September, the dot plot indicated just one rate cut in 2026, reflecting a cautious approach to monetary easing. 

This week’s update is expected to maintain a similar outlook, with policymakers signaling limited room for further cuts. The dot plot is likely to highlight divisions within the Federal Open Market Committee (FOMC), as some members advocate for a pause in rate cuts to avoid fueling financial imbalances.

Diverging Views Among Policymakers

The Fed’s decision-making process has been complicated by the absence of key economic data, as government delays have postponed the release of October and November employment and inflation reports. This has left policymakers relying on incomplete information to guide their decisions. 

While some officials, such as Kansas City Fed President Jeff Schmidt, have called for a pause in rate cuts, others, including New York Fed President John Williams, have argued for further easing to support the economy. These competing perspectives underscore the challenges facing the Fed as it navigates an uncertain economic environment.

Conclusion

The Federal Reserve’s final rate cut of 2025 is unlikely to surprise markets, but its implications for 2026 are significant. The updated dot plot and Chair Powell’s comments will provide critical insights into the Fed’s plans for the coming year, as policymakers balance the need to support economic growth with the risk of reigniting inflation. 

Investors should prepare for a cautious policy approach, with limited rate cuts and a focus on data-driven decisions. The Fed’s ability to navigate these challenges will be crucial in shaping the economic landscape in the months ahead.

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