It’s Fed day

In addition to the BoC update at 2:45 pm GMT – which is likely to be a dud – today's focus is squarely on the Fed rate decision at 7:00 pm GMT. While a -25 bp rate cut is largely priced in, which would bring the target rate to 3.50% - 3.75% (with investors assigning a 90% probability), the real question is what the Fed signals for next year. Consequently, I am not envisioning the rate decision to be much of a market mover. 

Fed expected to pause mid-year 2026

Interestingly, a cumulative -73 bps of cuts is currently implied until year-end 2026 – expected to occur in the first half of next year – marking a notable hawkish repricing from -87 bps recently. You may have also seen recent flows skewed towards dovish hedges in SOFR options for the first half of the year. This suggests markets believe the risk of policy easing is higher in early 2026 and that the Fed will likely pause after mid-year.

This also means that, assuming a rate cut today, two cuts are fully priced in for next year, bringing the target rate to a terminal of about 3.0%. US Treasury yields have largely risen since the beginning of the month, indicating that investors are looking beyond today’s policy cut to a more constrained path ahead.

You may recall that we got the delayed US September PCE inflation data last week, with the YY core measure coming in at 2.8%, down from 2.9% in August. Whilst somewhat of an improvement, the data remains stable but sticky, which is why the Fed’s forward guidance is important but so difficult. The challenge facing Fed Chair Jerome Powell and the voting Committee is that they know scarcely more now than they did in September, as the prolonged government shutdown delayed the release of official data.

Adding to this uncertainty, I recently noted the following in our week-ahead post:

‘Trump's forthcoming choice for Fed chair – widely expected to be NEC Director Kevin Hassett – could reshape expectations for 2026. Investors have expressed concerns that Hassett may prioritise Trump's preferences for aggressive easing, which could lead to higher inflation and volatility’.

Dots in focus

Today’s Summary of Economic Projections (SEP) will be widely watched. However, given the stark divide among Fed officials, I do not expect much change. September’s dot-plot projection will likely remain at 3.375% – implying just one more cut beyond this week's anticipated move. That said, it only takes a couple of officials to shift expectations for next year!

So, as I noted above, the question is not really about whether the Fed cuts or not – that is baked in – it is more so about what the Fed expects going forward. In terms of how I am looking at this event, my approach remains unchanged from what I added in our week-ahead post:

‘It will only take one or two dots moving lower to price in cuts next year! So, keep an eye out for this, as a move south would weigh on yields and the USD, while likely underpinning Stocks and Gold. The same can be said if we see the dots move higher, essentially showing that policymakers expect no cuts in 2026, which will naturally be positive for yields and the USD and negative for Stocks and Gold’.

BoC unlikely to offer much to trade

Following two back-to-back 25-bp rate cuts at the September and October meetings – bringing the overnight rate to 2.25% following cumulative rate cuts to 275 bps since June 2024 – the BoC appear set to press the pause button on their easing cycle. Money markets assign near-certain odds to a hold (93% probability), reflecting consensus that policy has done its part. In fact, if you look further out to 2026, money markets are actually expecting the central bank to hike rates.

You will recall from the last meeting that the BoC’s statement noted that the current policy rate is ‘at about the right level to keep inflation close to 2% while helping the economy through this period of structural adjustment’.

Bolstering a pause, we recently saw annualised Canadian Q3 25 GDP growth numbers came in better than expected at 2.6%, up from -1.8% contraction in Q2, along with November unemployment easing to 6.5% from 6.9% in October – its lowest level since mid-2024. Additionally, the October headline YY CPI inflation cooled to 2.2%.

I do not see much of a tradeable scenario from this event. However, albeit an outside chance, should the central bank’s language deliver a hawkish U-turn from the previous meeting, this could offer support to the CAD.