Baker Market Update 2025-12-12

The Federal Reserve delivered a much anticipated 25bp rate cut on Wednesday, its third consecutive cut this year, but paired the move with a cautionary message: don’t expect a straight-line easing cycle from here. In the press conference that followed the FOMC’s December meeting, Chairman Powell acknowledged that inflation “remains somewhat elevated.” He also noted that policymakers still lack sufficient visibility into a softening labor market, where data gaps and measurement issues complicate the outlook. In fact, Powell noted that the Fed believes monthly payroll gains are overstated by as much as 60,000, implying job growth may have been negative since April!

The Committee’s rate decision was unusually divided with two regional presidents dissenting in favor of no cut and a third pushing for a more impactful 50bp cut. Clearly FOMC members have differing views about whether persistent inflation or a weakening labor-market poses a greater risk to the economy. Powell acknowledged this tension in his comments, explaining that there is “no risk-free path for policy” for the Fed as it navigates its dual mandate.

Despite the internal divergence, the Committee does appear to agree on two key facts, 1. inflation is still too high and 2. the labor market has softened with further downside risk. Where the members differ is in how those risks are weighted and what individual forecasts imply going forward. Powell suggested that the Fed is now “well positioned to wait and see” how the economy evolves, a comment that is be widely interpreted to signal a pause in the cutting cycle. The Fed’s updated “dot plot” shows only one 25 bp cut in 2026 with another single cut in 2027, which is unchanged from the Fed’s September projections and notably more hawkish than market pricing. Futures markets are currently pricing in the next rate cut to come in June 2026 with just over two full cuts priced in by the end of 2026.

Markets also focused on the Fed’s announcement that it would begin purchasing $40 billion per month in Treasury bills. Powell stressed that this is not quantitative easing, but a reserve-management operation designed to maintain “ample” liquidity in the banking system. Even so, the Fed acknowledged that purchases may need to remain “elevated” for a few months before moderating, an implicit acknowledgment of short-term liquidity concerns.

Next week’s focus will be on November’s delayed Employment Situation Report, which is due out Tuesday, and CPI for November, which will be released Thursday. Have a great weekend!