The Fed cut rates again in December.
- The Fed cut policy rates by 25 basis points in December, its third consecutive reduction.
- However, the accompanying statement, press conference, and meeting minutes have clouded the outlook for future rate cuts.
- Given the divisions within the FOMC, the Fed’s updated “dot plot” showed a wide dispersion of views, with no clear consensus on the path for rates in 2026. The median dot shows one rate cut in 2026.
We believe the Fed has scope to continue easing this quarter.
- Our base case is that we will get one further 25-basis-point rate cut by the end of the first quarter. Labor market conditions remain soft.
- US inflation is likely to peak in the second quarter, in our view, before stabilizing toward the Fed’s 2% target.
- The DoJ investigation concerning Chair Powell does not materially alter the likely path for Fed rate cuts in 2026, in our view.
Lower interest rates strengthen the case for investors to put cash to work.
- Investors should consider phasing excess liquidity into diversified portfolios.
- To achieve alternative sources of portfolio income to cash, we see medium-duration quality bonds and equity income strategies as appealing.
- We also expect lower interest rates, robust corporate earnings, and AI tailwinds to support further gains for equity markets over the coming year.
New this week
Several Fed officials signaled a cautious approach to further rate cuts. Kansas City Fed President Jeff Schmid suggested that monetary policy should remain “modestly restrictive,” while San Francisco Fed President Mary Daly wrote that “policy is in a good place.”
Did you know?
- The Department of Justice (DoJ) launched a criminal investigation into Chair Powell’s June 2025 testimony to Congress regarding the Fed’s building renovations. While the investigation adds uncertainty to the timeline of potential leadership changes at the Fed, any adjustments to the policymaking framework are likely to be gradual.
- The Senate plays a key role in confirming the nominations of future governors and the next Fed chair. Senator Thom Tillis (R-NC) said he would oppose the confirmation of any nominees until the DoJ investigation is resolved. This could slow the confirmation of the next Fed chair.
- Cash tends to underperform other assets over time: Stocks have outperformed cash in 86% of all 10-year periods and 100% of all 20-year periods since 1926.
Investment view
Lower interest rates reduce potential returns on cash. We therefore recommend that investors consider phasing excess liquidity into diversified portfolios. We also like quality bonds, which can offer a more durable source of income. Investors underallocated to equities should consider adding to stocks in CIO's preferred areas, including AI, Power and resources, and Longevity.
