US: Fed’s 3+1 vs market’s 3+3 tussle. As expected, the US Federal Open Market Committee (FOMC) opted for a 25 bps cut at its September meeting, marking the resumption of its rate cut cycle. Having delivered 100 bps’ worth of cuts late last year, the Fed has been on pause throughout 2025, but recent signals from officials point to a need for some easing in light of weakening labour market conditions.
It is nonetheless striking that inflation pressures are higher now than a year ago, and so are long-term interest rates. Resuming a rate cut cycle at this stage is fraught with risks, a point underscored by Fed Chair Powell in his press statement. He conceded that it is not obvious what should be done at this juncture, reflecting the complexity of the current macro backdrop.
Although the Fed cut rates by 25 bps to 4.25%, it failed to out-dove the already dovish market pricing ahead of the decision. After a brief rally post the FOMC’s statement, US Treasuries sold off across the curve. Powell cites softening labour demand as justification for easing, but contradictions lay beneath the seemingly united voting pattern (i.e. 11 voting for a 25 bps cut and one dissent).
The dot-plot now shows a median of three cuts for 2025 and just one for 2026, marking a front-loading of rate cut expectations. This aligns with market pricing of close to two more cuts for the year. However, the dots also reveal a split in views; nearly half of FOMC participants see one cut or less for the rest of the year, and one dot even indicates a hike by year-end.
The contradictions deepen when considering the lower dot-plot trajectory despite firmer economic projections. The Summary of Economic Projections points to stronger GDP growth and lower unemployment over the next three years, while the forecast for core PCE inflation has been bumped up for 2026. This mix of variables should warrant less easing than the three cuts projected in June’s dot-plot. Yet, the Fed has pencilled in one additional cut by end-2026, suggesting a more dovish reaction function.
Just about all FOMC members now see two more rate cuts this year, but their view on 2026 is characterised by wide dispersion. The market is siding with the minority view that another three cuts are on the cards next year with a 3% terminal rate for the cycle. We think the majority view of a terminal rate of 3.5% will not be easy to sway, especially if inflation begins to surprise on the upside.
Tariff pass-through, labour market tightness owing to immigration crackdown, stimulatory impact of tax cuts, massive energy demand driven by AI-related spending, strong household and corporate balance sheets, and a booming equity market all point toward upside risks to inflation. We therefore maintain our view that the rate cut cycle will stall after 100 bps’ worth of cuts, two more this year and just one more in 1Q26.
Figure 1: Fed vs markets
Source: Bloomberg, DBS
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