The stock market may trade cautiously this week as it shifts to focusing on prospects for Fed monetary policy after a 25 BP cut on Wednesday. While the evidence suggests the Fed should keep the door open for more rate cuts in 2026, officials may want to present that possibility as not a certainty. This could result in some market volatility after the meeting, but would not rule out a year-end rally -- particularly if the November Employment Report (due December 16) or November CPI (due December 18) is benign.
A 25 BP cut at this week's FOMC Meeting will not be a surprise. What may be more important for the market is the extent of dissent among members. A positive surprise -- and one that should not be ruled out -- would be if there were only a few no votes, as in October (2 dissents, one of which was for a half point cut). Another positive surprise would be if Powell does not downplay the likelihood of further rate cuts in 2026, in contrast to the cautious tone he took at the October post-meeting news conference. If he sticks to the standard Fed line that policy will depend on the evolving economic evidence, the market may find his comments a relief.
The updated Central Tendency Forecasts will be important, as well. In September, they showed another two 25 BP rate cuts in 2026 (see table). The market will be looking to see if this forecast remains. Currently, the Fed funds rate is 3.75-4.0%.
As for the Central Tendency's Economic Forecasts (see table), the most important may be for inflation. In September, the y/y's for the PCE Deflator and Core PCE Deflator were both 2.8%. This is still above the Fed's 2% inflation target, but below the 2025 Fed forecasts. Total and Core need to rise by less than 0.2% m/m over Q425 for their y/y's to end the year below 2.8%. Nevertheless, the risk is for the Central Tendency Inflation Forecasts to be revised down for 2025 and possibly 2026. The latter would be a market positive.
Note that the latest University of Michigan Consumer Sentiment Survey shows a decline in longer-term inflation expectations to 3.2% in early December from 3.4% in November. These 5-year expectations are now back down to their range before the advent of tariffs (2.8-3.2%). This is good news for the Fed.
Regarding the other Central Tendency components, the risk is for the Real GDP Growth forecast to be revised up. Using the Atlanta Fed Model's 3.5% for Q325, Q425 Real GDP Growth would have to stall at +0.2% in Q425 to get to the 1.7% Q4/Q4 forecast. Such a sharp slowdown would likely be accompanied by higher Unemployment, which in September was 4.4%. So, the Q425 Forecast for the Unemployment Rate would likely be unchanged (if the Real GDP Forecast is upped) or be raised (if the Real GDP Forecast stays near 1.7%).
September Central Tendency Forecasts
(Q4/Q4 percent change, except for Unemployment Rate and Fed Funds Rate)
2025 2026
Real GDP Growth 1.4-1.7 1.7-2.1
PCE Deflator 2.9-3.0 2.4-2.7
Core PCE Deflator 3.0-3.2 2.5-2.7
Unemployment Rate * 4.4-4.5 4.4-4.5
Fed Funds Rate * 3.6-4.1 2.9-3.6
* Q4 level, percent
The latest evidence on the labor market continues to be mixed. The ADP Estimate has Private Payrolls falling in November after speeding up in October. In contrast, the Unemployment Claims data suggest the opposite, with October Payrolls weakening and then rebounding somewhat in November. Continuing Claims have done a better job than the ADP Estimate in tracking speedups/slowdowns in Private Payrolls (see first table below). A caveat is that Continuing Claims data have experienced unusually large revisions in the past two weeks, so their reliability in the latest week is a question. Challenger Layoff Announcements, presumably a precursor of layoffs and Unemployment Claims, were up on a y/y basis in November but substantially lower than in October (71k versus 153k). The latter suggests that weakness in job growth is not snowballing. The bottom line may be that the November Employment Report, due December 16, will show a sluggish trend in job growth -- which would justify the 25 BP rate cut and keep the door open for more cuts next year.
The delayed Q325 Employment Cost Index (ECI) will not likely influence this week's FOMC decision, as it will be released on the morning of the Meeting's second day. Evidence from Average Hourly Earnings (AHE) suggests the ECI will print at or near its 0.9% q/q trend (see second table below). If so, the ECI would not change the risks in the inflation outlook. A market-positive surprise would be if it prints 0.8% or less.
With wage inflation in check, a benign November CPI cannot be ruled out, particularly if Owners' Equivalent Rent stays low, as it did in September (latest report). The question will be whether more of the tariffs have been passed through to the consumer.
Private Payrolls (m/m change, 000s)
ADP Estimate First-Print BLS Latest-Print BLS Continuing Claims *
March 155 209 120
April 62 167 133 14
May 37 140 69 -74
Jun -33 74 -27 -57
Jul 104 83 77 18
Aug 54 38 -4 2
Sep -32 119 na 28
Oct 42 na na -41
Nov -32 na 14
* the inverted change in Continuing Claims between Payroll Survey Weeks, 000s
Wage Inflation Measures
(q/q percent change)
AHE ECI
Q325 1.0 na
Q225 0.8 0.9
Q125 1.0 0.9
Q424 1.0 0.9
Q324 0.9 0.8
Q224 1.0 0.9
Q124 1.0 1.0
