Even as the U.S. government shutdown drags on, there is still some business getting done in Washington D.C. The Federal Open Market Committee (“FOMC”) announced that it lowered the fed funds target rate by 25 basis points to 3.75% to 4.0% as the voting members continue to weigh the threat represented by a soft labor market, even without the data to back it up. Interestingly, there were two dissents to today’s rates decision: Stephen Miran, who once again voted for a 50-basis point cut, and Jeffrey Schmid, who voted to maintain rates at the previous level. In addition, the Fed announced an end to quantitative tightening on December 1st, having removed over $2 trillion from the Fed’s balance sheet since the program began in July 2022.
Driving the decision to cut rates were slowing job gains, at least through the last reporting period of August. The statement did, however, note the inflection higher in inflation from the beginning of the year, reflecting the pull through of higher costs due to tariffs. This concern about inflation was apparent during Fed Chair Jerome Powell’s press conference as well as he characterized today’s interest rate cut as a “risk management move” and cautioned that a rate cut in December was “not a foregone conclusion.” In addition to concerns about higher prices, Powell’s comments also seemed to amplify the view that the U.S. economy is delivering growth at a “moderate” pace and that there are members of the FOMC who are hesitant to cut rates if stronger growth is ahead.
Today’s decision to lower rates and wind down quantitative tightening are accommodative and certainly reflect the Fed’s continued concerns around the “curious” labor market. Even without the primary data typically available to the FOMC, secondary data, as well as recent company announcements, indicate that the pace of hiring remains slow and that layoffs may be accelerating. The resolution of the U.S. government shutdown should allow for a resumption in the collection and reporting of employment and inflation data, however, given the length and timing of the shutdown, we are likely to be evaluating a noisy set of numbers at least through the end of 2025. In addition, the specter of higher inflation due to a combination of higher costs and stronger growth looms a little larger today and shifts the focus back to the dual mandate.
Markets were surprised by the hawkish tone of the statement, Powell’s comments at the press conference, and the Schmid dissent. The probability of a Fed cut in December fell from over 90% to closer to 60%, and that could drift even lower in the next few weeks as the FOMC members hit the speaker circuit. Interest rate sensitive sectors were hit in the afternoon trading session, as were U.S. small caps; Treasury yields, and the dollar were higher on the news.
In terms of our investment views, we continue to anticipate that modestly lower rates and improving economic growth will provide a tailwind for small and mid-cap stocks as we move into 2026. In addition, the U.S. dollar is unlikely to strengthen against the current backdrop, which supports investment in non-U.S. equities. Finally, we believe there are opportunities in lengthening duration, as cash yields are drifting lower and there is a benefit to locking in yields further out on the curve.
