Winds shift, hawks circle

Everybody knows the Federal Reserve (Fed) will announce a 25bp rate cut today. I know it, you know it, he/she/it knows it, my five-year-old knows it, my cat, your dog, the birds in the sky. Everyone knows the Fed is lowering rates later today. Market pricing is giving it roughly an 88% probability — too high for the Fed to walk back in the absence of an emergency.

What we don’t know is what Fed members are planning for next year. How many cuts they anticipate, and whether their projections will convince markets to react accordingly.

For the doves, the case for rate cuts is clear: the US labour market has softened, partly due to a combination of aggressive anti-immigration policies, tariff uncertainty and fears around AI-related job displacement. Tariff-led price pressures, meanwhile, still haven’t shown up materially since tariffs were announced in April. Add to that the political noise — with Donald Trump pressuring the Fed to cut rates, at times with aggressive public remarks — and poor Jerome Powell is hearing things he probably never expected to hear in his lifetime.

For the most extreme doves, the Fed has “plenty of room” to cut. Kevin Hassett — one of Trump’s favourite candidates to lead the Fed next year — said yesterday that the rise of AI gives the Fed an opportunity to run easier policy because lower rates could lift both aggregate supply and demand. Higher supply, he argues, could help contain inflation.

Others think it may be wiser to pause for thought. AI-driven productivity gains are real. But looming inflation risks from tariffs still require a careful playbook — particularly if AI-driven disinflation doesn’t materialise fast enough to neutralize potential tariff-led inflation.

So, it’s complicated. All eyes will be on the Fed’s dot plot. Any hawkish tilt or reluctance to signal further cuts could trigger another repricing and weigh on sentiment.

The good news: investors aren’t walking into this meeting blindly. Money markets have already trimmed their expectations from 2–4 cuts next year to just two, reducing the risk of a sharp reaction to a “hawkish cut.”

And judging by yields, the message from investors is clear: they’re not buying the dovish narrative. Instead, investors worry that lower yields could revive inflation and ultimately prevent the Fed from cutting more — or even force a hike. The proof: the US 10-year yield has climbed since the Fed began cutting in September.

This disconnect between Fed policy and market yields suggests lower policy rates are not fully transmitting. No matter what Fed officials think, markets remain worried about inflation. They won’t absorb lower policy rates until they see evidence of inflation falling. That dynamic could prevent the S&P 500 from pushing higher into year-end.

Meanwhile, global winds are turning hawkish, as well. The Reserve Bank of Australia (RBA) said this week it debated an “extended pause or a hike,” and markets now price a rate increase by June — a stark reversal from expectations of a cut just a month ago. The Australian 10-year yield has jumped from ~4.10% in late October to above 4.80%.

The Bank of Canada (BoC) is expected to hold today, but markets are almost fully pricing a hike by late 2026, on the back of strong Canadian labour data. Canadian 10-year yields have risen from around 3% to near 3.50%.

The European Central Bank (ECB) isn’t expected to cut next year, and Isabel Schnabel said this week she’s comfortable with market pricing that the ECB’s next move could be a hike. The European 10-year yield is now around 2.85%, up from ~2.50% in October.

The Reserve Bank of New Zealand (RBNZ) watchers have also shifted from expecting a September cut to expecting a hike. The 10-year yield has spiked from ~4% to above 4.6%.

And the Bank of Japan (BoJ) is widely expected to hike next week. The Japanese 10-year is flirting with 2%, raising the risk of Japanese pension funds and insurers — major US Treasury holders — repatriating capital back home, and pull the rug from under the feet of US treasuries.

Consequently, even though equity investors still debate whether the tech sector is in bubble territory, global bond investors have little doubt about two things: DM debt is unsustainably high, and central bank expectations are shifting hawkish. The latter pushes the yields higher.

And if yields continue pushing higher, valuations will come under pressure — especially for highly leveraged companies.

So, today’s reaction to the Fed will likely set the tone for the remainder of the year: will Santa bring gifts, or stay snowed out? Answer in a few hours.