The Federal Reserve’s last meeting of 2025 kicks off next week. Expectations of a 0.25% interest rate cut are running high (around 89%).
One of the major factors behind that stems from New York Fed president (and FOMC vice chairman) John Williams’ comments that rates could fall in the near term without fueling inflation. That raised hopes for a cut next week.
Plus, recent data showed mixed signals for the economy, potentially giving the Fed room to maneuver.
This week, the Institute of Supply Management’s Purchasing Managers Index showed that the Services sector continued to expand in November with its strongest performance since February. Yet Manufacturing remained under pressure with its second-lowest reading in a year.
Then there’s sluggish retail sales. And ADP data showed that private businesses shed 32,000 in November (against a 47,000 gain in October).
Barring a big breakout in Personal Consumption Expenditures (PCE) inflation data today, the stage appears set for a rate cut next week (even though I remain convinced it’s unnecessary).
Importantly, waffling rate cut expectations could keep the market walking on a tight rope as we head into 2026…
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While markets are already factoring in a cut next week, we’ll need to closely watch any comments from Fed chair Jerome Powell.
Of course, he’s due to step down at the end of his term in the first half of 2026. Kevin Hassett, the current favorite to replace him, will be agitating to cut rates if he gets the job.
But until that time, markets will be looking for any clues from Powell about the Fed’s plans in 2026. If the Fed does adopt a neutral stance, that might give some folks an excuse to sell stocks.
As I’ve been saying on my podcast, I’m not expecting a major sell-off with just a couple of full weeks of trading to go in 2025. But we could be in for a short, sharp retracement – especially if the Fed changes course unexpectedly.
Just a few weeks ago, stocks fell sharply when the mere prospect of a December rate cut dimmed. That shows how sensitive stocks are to expectations around rates.
The other thing to watch is Powell’s take on the economy. Some of the business folks I talk to are seeing a slowdown…
While it’s easy to focus on the breakneck rally since April this year, recall that this bull run ultimately goes back to October 2022. So this rally is now into its fourth year. Without fresh fuel, we could soon see it start to sputter.
The market’s lofty valuations will increasingly be tested.
While I’m not predicting a full-on crash right now, I remain incredibly leery. A lot rests on interest rates to prop up the market. But the future of rate cuts remains far from certain.
Even if we get a December rate cut, 2026’s rate path is far from clear. And as soon as cuts halt, the market could be in for a rude awakening.
Plus, if data starts pointing to weakness in the economy, that could provide another catalyst for a sell-off.
All said, we may be facing sharply higher volatility in the new year… which will provide many trading opportunities ahead.
Happy Trading,
Larry Benedict
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