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Key takeaways
At its October 2025 meeting, the Fed cut their policy interest rate by 0.25%, with future cuts possible but not guaranteed.
Inflation remains above target, but labor market weakness is also influencing Fed policy decisions.
Investors maintain expectations for policy rate cuts with interest rates pricing in a near-3% policy rate by the end of 2026, more than Fed projections
The Federal Reserve (Fed) cut its target federal funds interest rate by 0.25%, setting its new target range to between 3.75-4.00% following the Federal Open Market Committee’s (FOMCs) regularly scheduled two-day meeting. Investors widely anticipated this outcome, but two of the twelve FOMC voters dissented: one preferred a 0.50% cut while another favored no cut. Investors also place high odds of one more rate cut this year followed by three additional cuts next year.1 However, Fed Chairman Jerome Powell noted a December rate cut is “far from” certain.2
Interest rate markets have shifted target policy rate expectations at year-end 2026 from 3.25% to about 2.9% after the Bureau of Labor Statistics downwardly revised past hiring data.1 Fed Chair Powell expressed caution about future cuts, citing inflation holding above its 2% target while acknowledging softer labor market conditions. The Fed previously held rates steady this year, mainly due to tariff uncertainty and above-target inflation. The Fed funds target represents overnight lending rates between financial institutions and strongly influences borrowing costs and the broader interest rate environment.
Inflation remains elevated but it has not accelerated as much as many economists feared after President Donald Trump's tariff policies raised concerns about their economic impact. Business “prices paid” surveys and rising tariff revenue could lift goods inflation further, prompting the Fed to maintain a data-driven approach to policy decisions. Chair Powell stated during the press conference that “policy is still modestly restrictive,” leaving room for additional rate cuts if risks to the labor market continue offsetting risks of higher inflation, or if inflation subsides.2
He previously noted in September, “to the consumer, the pass through [of tariffs] has been pretty small,” but that companies intend to pass along more cost increases.3 The Fed will next consider rates at its December 9-10, 2025 meeting, with markets implying an 72% chance of another 0.25% cut. Market prices also indicate expectations for further cuts next year, which would bring the policy rate near 3.0%.1
Bill Merz, head of capital markets research with U.S. Bank Asset Management Group, notes labor market weakness played a larger role in the Fed’s interest rate decisions at both of their most recent meetings, and will continue to be a primary decisioning factor. “Negative labor market revisions indicate a softer hiring picture over the last year and a half, but higher income consumers continue to drive solid aggregate consumer spending,” says Merz. Recent stock market strength suggests investors believe the Fed is responding to past soft data, such as downward revised job gains, not future growth concerns. Merz notes that U.S. economic growth estimates and corporate earnings growth expectations continue moving higher, according to consensus estimates.
Fed balance sheet stabilization in sight
The Fed previously bought bonds, for its balance sheet, during and after the Covid pandemic to reduce longer term borrowing costs. In June 2022 the Fed shifted to reducing its balance sheet by not replacing a certain amount of matured bonds. The Fed just announced that it will cease reducing its $6.3 trillion in holdings on December 1, after slowing the monthly reduction earlier this year. Bond holdings peaked at $8.5 trillion in 2022. Halting balance sheet reduction improves market liquidity as investors will not need to absorb the additional bond supply. Liquidity refers to the amount of money readily available to buy goods, services, and financial assets in an economy. Strong liquidity provides a cushion against financial market shocks, and current liquidity measures remain constructive. The Fed’s actions aim to support market stability and ensure sufficient funds are available for economic activity. Investors should monitor liquidity trends as the Fed adjusts its balance sheet strategy.
“Negative labor market revisions indicate a softer hiring picture over the last year and a half, but consumer spending remains solid. For now, stock market strength indicates investors interpret current and future rate cuts as responding to past data, rather than indicative of lower future growth.”
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Bill Merz, head of capital markets research at U.S. Bank Asset Management Group
Managing inflation and unemployment
Aggressive rate hikes from early 2022 to mid-2023 helped drive the Core Personal Consumption Expenditures price index (Core PCE), the Fed’s preferred inflation gauge, from above 5.5% year-over-year in 2022 to 2.9% in September 2025.4 To achieve its price stability mandate, the Fed targets a 2% average inflation rate.
The Fed also has a mandate to maintain maximum employment, and recent labor market data points to a softer hiring environment. The August non-farm payroll report showing only 22,000 net new jobs and the September private employment report from Automatic Data Processing, a payroll service provider, indicated a decline of 32,000 jobs. Additionally, the Bureau of Labor Statistics revised past job growth for the 12 months ending March 2025, revealing lower average job growth than initially reported. However, the nation’s unemployment rate stands at a low 4.3%.5 Despite weaker hiring, weekly initial jobless claims reports, considered by economists to be a real-time source of labor market trends, remain low and relatively stable. “If weekly initial claims exceed 300,000, markets would likely reflect discomfort” says Haworth. Continuing jobless claims are slightly higher than recent years, indicating those without jobs are having a harder time finding employment.6
Market reactions and investment opportunities
Stocks recovered after significant volatility in April, following President Trump’s new tariff initiatives, with the S&P 500 repeatedly reaching all-time highs.7 Meanwhile, most traditional bond categories have delivered solid year-to-date returns in the 6-8% range. Ten-year U.S. Treasury note yields fell near 4.0% in September and earlier in October as investors priced in expectations for additional rate cuts, and currently stand near 4.1%.
Yields are somewhat lower than longer-term historical norms, but higher than the last decade.8 Given continued inflationary concerns, bond investors should explore ways to diversify fixed income holdings beyond U.S. Treasury securities. Opportunities exist in high-yield municipal bonds for highly-taxed investors, structured credit such as collateralized loan obligations (CLOs), non-government agency backed mortgages, and catastrophe bonds or reinsurance for qualified investors. Treasury Inflation Protected Securities (TIPS) can also help defend against an unexpected rise in inflation.
Consult your financial professional and review portfolio positioning to ensure your investments align with current market conditions and future expectations.
Frequently asked questions
A nation’s central bank, which in the United States, is the Federal Reserve (Fed), typically controls monetary policy. The Fed’s management of monetary policy can have a significant impact on the shape of the nation’s economy. Congress’ mandate for the Fed is to maintain price stability (manage inflation); promote maximum sustainable employment (low unemployment); and provide for moderate, long-term interest rates. Fed monetary policy influences the cost of many forms of consumer debt such as mortgages, credit cards and automobile loans.
The Fed is the nation’s central bank, and perhaps the most influential financial institution in the world. The central governing board of the Federal Reserve reports to Congress, while the President appoints the chair of the Federal Reserve. There are also 12 regional federal reserve banks that are set up like private corporations.
The Federal Reserve’s Federal Open Market Committee (FOMC) sets a target interest rate policy for the federal funds rate. This is the rate at which commercial banks borrow and lend excess reserves to other banks on an overnight basis. The Fed raises lowers the rate to impact underlying economic conditions. For example, in 2022, as inflation surged, the FOMC began raising interest rates to make borrowing more expensive and slow economic activity. The Fed designed that strategy to ease pricing pressures and reduce the inflation rate. In periods when the economy is slow or in a recession, the Fed tends to lower rates to try to stimulate economic activity and help the economy expand again.
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