Rate Decision | Date: January 25/26, 2026
Probabilistic assessment of the next Federal Reserve policy decision using integrated US and global macro regimes.
Fed Policy Advisor: Rate Decision Outlook
Fed Reaction Function – Weighted Channel Assessment
Cycle-sensitive decomposition of the Fed’s reaction function across key inputs and inferred policy bias.
| Channel | Signal Direction | Momentum | Fed Sensitivity (Contextual Weight) | Policy Push |
|---|---|---|---|---|
| Inflation & Prices | Moderating | Weakening | Low | CUT |
| Labour Market | Cooling | Accelerating | High | CUT |
| Growth & Demand | Slowing | Broad-based | Medium | CUT |
| Liquidity & Financial Conditions | Easing | Rebounding | Low | HOLD |
| Credit & Risk Transmission | Tightening | Persistent | High | CUT |
| Global & USD Backdrop | Weak demand | Stable | Medium | CUT |
| Market Pricing & Positioning | Dovish | Firming | Medium | HOLD or CUT |
| Fed Communication / Reaction-Function | Cautious easing tone | Reinforced | High | CUT |
Conclusion: Weights reflect a late-cycle, asymmetric Fed reaction function prioritizing downside labor and credit risks over lingering inflation. The net directional bias from the weighted assessment points toward: CUT.
Executive Summary
The macroeconomic regime is characterized by a late-cycle slowdown, marked by a softening labor market and emerging credit stress, set against a backdrop of persistently elevated but potentially transient inflation. The Federal Reserve's tone is explicitly dovish, having executed three consecutive rate cuts and initiating measures to actively ease liquidity conditions by ending quantitative tightening (QT) and starting purchases of shorter-term Treasury securities (1)(2). This shift in policy bias is a direct response to rising downside risks to employment and underlying financial vulnerabilities (1).
The labor market continues to exhibit cooling tendencies, with job gains slowing, the unemployment rate edging up to 4.4% in September, and rising underemployment (U-6 at 8.7% as of November 1, 2025) (3)(3 of US Labour Market). Worker confidence is weakening, and job dynamism is waning (5 of US Labour Market)(8 of US Labour Market). While headline and core PCE inflation remain somewhat elevated at approximately 2.8% year-over-year as of September 30, 2025 (2 of US Inflation & Price Dynamics), the Fed views much of this as tariff-driven and likely a "one-time price increase" expected to peak in Q1 2026 (1, referencing Oct 29, 2025 PC). Market-implied inflation expectations remain stable and anchored (4 of US Inflation & Price Dynamics).
Liquidity conditions are easing, with the Federal Reserve Liquidity Composite showing an Expansionary regime driven by the significant unwind in the Overnight Reverse Repo (ON RRP) facility (1 of US Liquidity & Monetary Conditions). M2 money supply is also re-accelerating, further supporting financial conditions (2 of US Liquidity & Monetary Conditions). Credit conditions are a point of concern, with the STLFSI4 Financial Stress Index in a "Bearish" regime, indicating elevated systemic tension, despite broader credit spreads remaining "Normal" (4 of US Credit Conditions)(1 of US Credit Conditions). Global growth signals are mixed but indicate persistent industrial demand tailwinds, with some extreme speculative positioning in commodities that could lead to volatility (3 of Global Growth & Economic Cycles)(7 of Global Growth & Economic Cycles). Market pricing, particularly in Fed Funds futures, reflects strong expectations for further rate cuts (4 of Cross-Asset Positioning & Sentiment).
Given the Fed's proactive stance in addressing mounting downside employment risks and underlying credit stress, and its apparent willingness to look past current elevated inflation, the probability of a further rate cut at the next FOMC meeting remains high.
Probabilistic Assessment for the NEXT FOMC Policy Decision
For the next FOMC meeting (following December 10, 2025):
- CUT: 60%
- HOLD: 40%
- HIKE: 0%
Regime & Channel Logic
1. Inflation Channel
The US inflation environment is marked by disinflationary trends in realized prices despite elevated spot levels. The overall Fed Inflation Signal is in a COOL regime (1 of US Inflation & Price Dynamics), indicating weak inflation pressure. Policy-relevant PCE measures (headline 2.79%, core 2.83% YoY as of September 30, 2025) are categorized as Neutral but remain above the 2% target (2 of US Inflation & Price Dynamics). However, Chair Powell has consistently framed current elevated inflation as "one-time price increases" primarily due to tariffs, expected to peak in Q1 2026, and believes non-tariff inflation is in the "low 2s" (1, referencing Oct 29, 2025 PC). Market-implied inflation expectations and the inflation term-structure are both STABLE/Neutral, indicating anchored long-term outlooks but with recent negative momentum (4 of US Inflation & Price Dynamics)(5 of US Inflation & Price Dynamics). The CPI-PPI divergence has normalized to NEUTRAL, with a positive PPI-minus-CPI differential and upward 3-month momentum, suggesting emerging cost-push pressures (3 of US Inflation & Price Dynamics). Given the Fed's dovish pivot and focus on employment risks, the lingering inflation, while noted, is downweighted as a primary driver for tightening.
2. Labour-Market Channel
The labor market is demonstrably cooling, consistent with a late-cycle phase and amplifying the Fed's dovish bias. Employment levels have declined slightly, with weaker labor demand across several districts and increasing layoff announcements, although aggregate layoffs are not sharply rising (16). The unemployment rate edged up to 4.4% in September, and the median SEP projection for 2025 is 4.5% (3). The Explicit Slack Gap is NEUTRAL but hints at widening (1 of US Labour Market), and Underemployment (U-6) is rising (8.7% with a z-score of 1.40 as of November 1, 2025), signaling increasing hidden slack (3 of US Labour Market). Labor Market Turnover is Bearish, indicating weakening worker confidence (5 of US Labour Market), and Job Flows show waning dynamism (8 of US Labour Market). These signals reinforce the Fed's explicit concern about "downside risks to employment" (2), making this a high-sensitivity channel strongly advocating for further easing.
3. Growth & Demand Channel
Economic activity appears to be slowing overall, with varied reports across districts. The October and November Beige Books describe activity as "changed little" or showing "modest declines," with consumer spending inching down or declining further, particularly for lower-income households (16). Business investment in AI and data centers remains strong, providing some offset. While the latest SEP (December 10, 2025) projects a slightly stronger real GDP growth for 2026 (2.3% from 1.8% in September) (4 of Fed Tone Decoder), this forward optimism is contrasted by current moderation and downside risks to growth mentioned in the Beige Book, including from a prolonged government shutdown (16). The Fed is acting to support overall economic activity by easing policy, suggesting a cut is aimed at mitigating a broader slowdown.
4. Liquidity & Financial-Conditions Channel
Liquidity conditions are easing, influenced by direct Federal Reserve actions. The Federal Reserve Liquidity Composite is in an Expansionary regime (1.78 in December 2025), primarily due to the sharp decline in Overnight Reverse Repo (ON RRP) usage (1 of US Liquidity & Monetary Conditions). M2 money supply growth is Bullish, indicating a re-acceleration in broad money (2 of US Liquidity & Monetary Conditions). The 10-year real yield is Neutral, stabilizing after a period of decline (3 of US Liquidity & Monetary Conditions), and the Neutral Rate (r*) Proxy is Near Neutral (2 of US Growth & Business Cycle). SOFR futures positioning shows increasing speculative long conviction for less restrictive policy, though hedgers remain cautious on the front-end (6 of US Liquidity & Monetary Conditions)(7 of US Liquidity & Monetary Conditions). The Fed's decision to initiate Treasury purchases to maintain ample reserves also signals a proactive easing of financial conditions (2). This channel is currently supportive of, rather than demanding, further rate cuts.
5. Credit & Risk Channel
US credit conditions present a nuanced risk profile. While the Credit Spreads Composite is "NORMAL" (z-score -0.13), indicating historically low absolute spreads for high-yield and investment-grade debt, there is positive momentum suggesting recent widening (1 of US Credit Conditions). More critically, the standalone Financial Stress Index (STLFSI4) is in a "Bearish" regime (z-score 0.906 as of December 12, 2025), signaling elevated systemic tension (4 of US Credit Conditions). This divergence suggests underlying financial fragility despite benign aggregate measures. Banking contacts have reported weaker loan demand, rising consumer delinquencies (especially for business loans and subprime auto), and tightening lending standards (1, referencing Oct 28-29, 2025 Minutes). The Fed is explicitly monitoring credit quality and potential losses (1, referencing Oct 29, 2025 PC). This elevated financial stress and risk transmission create a strong impetus for further easing to support credit availability and stability.
6. Global & USD Backdrop
The global environment shows a weakening US Dollar Index, falling below its 12-month moving average (1 of Global Inflation & FX Dynamics). This typically implies easing global financial conditions but also a potential for reduced US demand. Global growth is characterized as a "Resilient Mid-Cycle with Metals-Led Tailwinds" by the Energy-Adjusted Metals Tailwind (8 of Global Growth & Economic Cycles), indicating robust industrial demand. However, CoT positioning in copper shows "Elevated_Risk" with extreme speculative long and hedger deep short positions (3 of Global Growth & Economic Cycles), and WTI crude oil has a "Hedgers_Deep_Short" regime with high reversal risk (7 of Global Growth & Economic Cycles), suggesting underlying supply concerns or expectations of future price declines. FX vulnerability in major G10 currencies (AUD, JPY, GBP) is elevated due to extreme positioning (4 of Global Inflation & FX Dynamics)(6 of Global Inflation & FX Dynamics)(7 of Global Inflation & FX Dynamics). While there's a disinflationary bias from the weakening USD, global growth is not uniformly strong, and international developments contribute to the overall elevated uncertainty acknowledged by the Fed.
7. Market Pricing & Positioning
Cross-asset positioning signals a dovish market expectation for monetary policy. Fed Funds futures show extreme speculative long positioning and hedger deep short positions, indicating strong conviction among speculators for further rate cuts (4 of Cross-Asset Positioning & Sentiment). This "Elevated_Risk" synthetic state for Fed Funds points to a market that has aggressively priced in easing. Overall market volatility (VIX) is "NORMAL" (1 of Cross-Asset Positioning & Sentiment), but there is "High Squeeze Risk" across futures markets (6 of Cross-Asset Positioning & Sentiment), indicating potential for sharp reversals if policy deviates significantly from expectations. While the Fed emphasizes it is "not on a preset course" (1, referencing Oct 29, 2025 PC), the strong dovish market pricing makes it easier to continue cutting if other economic factors align, to avoid dislocating expectations. However, the existing internal divergence within the FOMC (some members preferred no change to the target range in previous meetings) (2) and Powell's "wait and see" rhetoric for future meetings introduce a non-zero probability for a pause.
8. Fed Communication / Reaction-Function Channel
The Fed's communication has exhibited a clear and consistent dovish pivot since September 2025, culminating in three consecutive 25bps rate cuts (September, October, December) (2). This shift is driven by an explicit judgment that "downside risks to employment have risen" and a need to balance the dual mandate, with employment concerns now taking precedence over still-elevated inflation, which is largely attributed to temporary tariff effects (1). Furthermore, the Committee decided to cease balance sheet runoff as of December 1 and initiated purchases of shorter-term Treasury securities to maintain ample reserves (2), signaling a proactive easing of liquidity. While there are "strongly differing views" internally on the future path of rates and a stated intention to "wait and see how the economy evolves" before additional adjustments (1, referencing Dec 10, 2025 PC), the overall momentum and articulated risk asymmetry strongly reinforce an easing bias.
Overall Assessment of Policy Trajectory
The current macroeconomic environment and the Federal Reserve's reaction function create a strong predisposition towards further monetary easing. The persistent cooling in the labor market, increasing signs of underemployment and waning worker confidence, combined with elevated underlying financial stress, are clearly prioritized by the dovish-leaning Committee. While inflation remains above target, the Fed appears willing to treat it as a temporary phenomenon (tariff-driven) and is focused on preventing a sharper economic downturn.
The three consecutive rate cuts and the cessation of quantitative tightening demonstrate a proactive risk-management approach. Market expectations are already pricing in further cuts, creating an environment where continuing to ease is less disruptive than an unexpected hold, provided economic data doesn't dramatically re-accelerate. Despite Chair Powell's "wait and see" rhetoric and internal disagreements on the pace of future cuts, the cumulative evidence of slowing employment and increased downside risks, alongside the easing liquidity stance, points to a higher probability of another rate cut to reach a more neutral policy setting.
Fed Policy Advisor – Rate Decision Outlook (Cut / Hold / Hike Probabilities)
Based on the comprehensive assessment of current macro signals, Fed communications, and the inferred reaction function, the probabilistic outlook for the *next* FOMC policy decision is:
CUT: 60%
HOLD: 40%
HIKE: 0%
Missing Content / Critical Improvements
- The Macro Theme: US Growth & Business Cycle signal document was not provided. This is a critical input for a comprehensive assessment of the broader economic cycle, which directly impacts the Fed's dual mandate (maximum employment) and risk asymmetry considerations. Its absence requires reliance on scattered qualitative commentary, reducing confidence in the overall growth diagnosis.
- The Policy-Relevant Inflation (PCE) signal data (latest as of 2025-09-30) and Wage Growth and Inflation Composite signal data (latest as of 2025-10-01) are older than other provided signals (e.g., Fed Inflation, MIIE, Term-Structure, all as of 2025-12-31). Providing the most recent data for all core inflation and wage signals would enhance the timeliness and precision of the inflation and labor market assessments.
- Detailed component contributions or breakdown for the Fed Inflation Signal beyond its composite score would further enhance the analysis by allowing specific drivers (e.g., CPI, breakevens, money supply) to be explicitly linked to the overall regime and recent trends, improving transparency and confidence in the inflation diagnosis.
- The Private Credit Impulse signal for December 2025 has missing data for Commercial & Industrial Loans (BUSLOANS) and Total Consumer Loans Owned by Banks (TOTALSL) 6-month annualised growth rates. This incompleteness hinders a full and precise assessment of private credit momentum for the latest period and may impact the composite's accuracy in the Credit & Risk Transmission channel.
- The full text for the FOMC Statement and Minutes from July 29-30, 2025, linked via RSS, were not provided. These documents would offer crucial context for the initiation of rate cuts and the evolving risk assessment preceding the September decision.