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Key takeaways
At its December 2025 meeting, the Fed cut their policy interest rate by 0.25% and signaled a measured approach to future policy changes.
Market liquidity remains strong, and investment opportunities exist beyond traditional U.S. Treasury securities, especially for diversified fixed income strategies.
Investors should monitor Fed policy, inflation trends, and labor market data, and consult financial professionals to align portfolios with changing market conditions.
The Federal Reserve (Fed) recently reduced its target federal funds interest rate by 0.25%, setting a new range to between 3.50-3.75% after its scheduled Federal Open Market Committee (FOMC). While investors widely anticipated this move, three of the twelve FOMC voters dissented, one preferred a larger cut while two favored no change. Investors expect at least two additional cuts next year, reflecting ongoing uncertainty in the economic outlook. 1
Chairman Jerome Powell highlighted labor market weakness and suggested that tariff-related price pressures on core goods should peak in the first quarter, signaling openness to future rate reductions. 2 Surveys of Fed members indicate a more constructive growth outlook and lower inflation expectations for 2026 compared to previous forecasts. 3 The Fed’s decisions remain data-driven, with future policy adjustments likely if risks to employment or inflation persist.
Recent labor market data from the Bureau of Labor Statistics, Automatic Data Processing (a payroll company), and other sources have contributed to the Fed’s three consecutive rate cuts, despite inflation remaining above its target. Earlier in the year, the Fed held rates steady, citing tariff uncertainty and persistent inflation. The federal funds target represents overnight lending rates between financial institutions and shapes borrowing costs and broader interest rate trends.
Inflation remains elevated, 4 but it has not accelerated as much as feared following President Donald Trump's new tariff policies. Business “prices paid” surveys point to easing inflation expectations, and shelter costs – an important inflation component - should continue falling. However, rising tariff revenue could push goods inflation higher in coming months, prompting the Fed to maintain a cautious, data-driven approach. Chair Powell noted that policy is near the high end of a neutral range, leaving room for additional rate cuts if risks to the labor market increase, or if inflation subsides. 2 A neutral policy rate is one which neither stimulates nor detracts from economic activity.
According to Bill Merz, head of capital markets research with U.S. Bank Asset Management Group, labor market weakness will remain a key factor in Fed decision-making. “Negative labor market revisions and recent data indicate a softer hiring picture, but higher income consumers continue to drive solid aggregate consumer spending,” says Merz. He notes that U.S. economic growth estimates and corporate earnings growth expectations continue moving higher, according to consensus estimates.
Fed balance sheet and market liquidity
Liquidity refers to the amount of money readily available to buy goods, services, and financial assets in an economy. The Fed previously expanded its balance sheet by purchasing bonds during and after the Covid pandemic to lower long-term borrowing costs. As of December 1st, the Fed stopped shrinking its $6.2 trillion bond holdings, which peaked at $8.5 trillion in 2022. The Fed will now buy short-term Treasury bills to maintain ample banking system reserves and keep short-term interest rates near policy targets, supporting market liquidity and cushioning against market shocks.
“Negative labor market revisions and recent data indicate a softer hiring picture, but higher income consumers continue to drive solid aggregate consumer spending”
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Bill Merz, head of capital markets research at U.S. Bank Asset Management Group
Inflation and employment mandates
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 2.8% in September 2025. 5 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 point to a cooling in hiring. September non-farm payrolls rose by 119,000 net new jobs, 4 recovering from earlier weak reports, while the private employment estimate from Automatic Data Processing showed a decline of 32,000 jobs. 6 The unemployment rate stands at 4.4%, still low by historical standards, but is drifting higher. 4 Weekly initial jobless claims reports remain low and consistent with previous seasonal patterns, yet continuing jobless claims have moved above recent years, indicating that job seekers are taking longer to find work. 7 Together, these signals suggest a softer labor backdrop that Fed policymakers will weigh alongside inflation in upcoming decisions.
Market reactions and investment opportunities
The S&P 500 has gained over 18% year-to-date, rebounding after significant volatility in April linked to President Trump’s new tariff initiatives. 8 Meanwhile, most traditional bond categories have delivered solid year-to-date returns in the 6-8% range, while ten-year U.S. Treasury note yields have remained between 4.00-4.25% in recent months after starting the year near 4.50%. Yields are somewhat lower than longer-term historical averages, but higher than the previous decade. 9
We continue encouraging investors to 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. 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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