It's all about the FOMC this week. A 25 basis point cut to the 3.5-3.75% range is priced into markets with the CME Fedwatch tool showing a 90% probability as of Monday’s close.

Of importance will be the vote and forward guidance. The October 28-29 meeting was very contentious. The vote was 10-2 with one dovish dissent and one on the hawkish side. But it could have been worse than that as Chair Powell noted in his presser that there were some "strongly differing views on how to proceed."

Markets expect the quarter point cut Wednesday to be accompanied with a hawkish guidance that suggests the potential for a pause at the January 27-28 meeting, with Chair Powell stressing data dependence again. It will be interesting if those factors will be enough to appease policymakers and limit dissents. Meanwhile, fresh dots will be released and it is not clear the medians will change much from September given the lack of data, though there is likely to be a wide dispersion of the individual outlooks. Last quarter's medians showed a 3.6% rate for this year, 3.4% for 2026, and 3.1% for 2027 and 2028.

The FOMC's decision-making process is complicated by conflicting economic signals, some of which are dated due to a recent government shutdown. The most recent inflation data for September 2025 showed headline Personal Consumption Expenditures (PCE) inflation at 2.8% and core PCE at 2.9%, both still above the Fed's 2% target.

The latest available Consumer Price Index (CPI) for September was 3%. On the other hand, the labor market has shown signs of cooling. The unemployment rate for September 2025 rose to 4.4%, its highest in four years, and private-sector reports indicated job losses in November. These indicators are pushing for rate cuts to support employment.

A rate cut is generally seen as positive for equities, potentially fueling a year-end "Santa Rally" by making riskier assets more attractive. The S&P 500 (SPX) has approached all-time highs recently, partly on rate cut optimism. A "dovish cut," which signals more easing in 2026, could benefit value stocks, utilities, energy, real estate, and small-caps.

The bond market has been volatile, with some analysts suggesting that cutting rates while inflation remains a concern could actually lead to higher long-term yields and a steeper yield curve. The benchmark 10-Year Yield nearly hit 4.2% on Monday and is at its highest level in over 2 months despite the rate cut outlook. The Fed's updated "dot plot" (Summary of Economic Projections) will be crucial for bond market direction, as it will outline policymakers' future rate expectations.

The significant division among Fed officials (hawks vs. doves) makes the exact messaging from Chair Jerome Powell's press conference Wednesday afternoon highly anticipated, as it will set the tone for monetary policy heading into 2026.

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