The Fed is heading for an extended pause, unlike the Bank of Japan

The FOMC decided to keep interest rates steady at 3.5% – 3.75% at its 27–28 January meeting, following three consecutive rate cuts at the end of 2025. Solid economic growth and easing concerns about employment prompted this decision, and we now expect the Fed Funds target range to remain stable throughout 2026, with no interference from the question of Chair Jerome Powell's replacement. As such, the Fed would join the ECB in maintaining the status quo. The Bank of Japan and the Bank of England would continue to be exceptions: the former by raising rates and the latter by continuing its gradual easing.

A widely expected rate decision

The outcome of the FOMC's first meeting of 2026 was no surprise, with a 98% market probability that the target range would remain at 3.5% – 3.75%. Two governors, Christopher Waller and Stephan Miran, dissented and voted in favour of a 25bp cut. In December, Fed Chair Jerome Powell had mentioned that monetary policy was ‘well positioned’, and the GDP, employment and inflation data released since then did not suggest that further action would be needed.

BNP Paribas scenario: Rebalancing completed

The cycle of rate cuts restarted in September 2025 (-75bps in total) intended to bring monetary policy closer to neutrality in the face of increasing risks surrounding the “maximum employment” component of the Fed's dual mandate. However, US growth remains dynamic, as it is expected to reach +2.9% in 2026 (after +2.3% in 2025) thanks to resilient domestic demand (consumption and nonresidential investment), which would mark the fourth consecutive year of above-potential growth. While the issue of “K-shaped growth” or “jobless growth” will likely remain a major theme in the US economy in 2026–2027, this is outside the Fed’s scope of competence in the absence of a move away from full employment.

For this reason, the decline in private payroll growth in 2025 (+61k monthly average, vs. to +130k in 2024) must be viewed within the context of the slowdown in supply and the relative stability of layoffs (1.7 million per month in 20251 as in 2024) and in the unemployment rate, which is mitigating concerns. The FOMC statement removed the reference to a recent rise in ‘downside risks to employment’, while the rate cuts at the end of 2025 have not yet taken effect. Furthermore, while Jerome Powell does not expect second-round effects from tariffs on price levels, the actual and expected persistence of inflation above target (we anticipate an average CPI of +2.7% in 2026, stable compared to 2025) is reducing the likelihood of rate cuts. These developments, combined with Powell's optimism about future progress on both components of the dual mandate, point to stability in the Fed Funds target throughout 2026, at 3.5% – 3.75%.

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