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Fed’s December Dilemma: Rate Cuts, Risks and Reversals

Shailender Kumar

The Federal Reserve faces a split decision in December as policymakers debate a possible rate cut amid slowing growth, inflation concerns, and shifting market expectations.

Fed’s December Dilemma: Rate Cuts, Risks and Reversals

The upcoming December Dilemma Federal Open Market Committee (FOMC) meeting may be the most consequential Federal Reserve decision in years. The U.S. central bank, navigating a fragile economic landscape marked by softening labor markets, inflation above target, volatile financial conditions, and political pressures, is now widely expected to execute another quarter-point rate cut.

Morgan Stanley, one of the world’s largest financial institutions, delivered a stunning reversal earlier this week: it now anticipates a 25-basis-point cut in December after previously predicting no change. It joins J.P. Morgan and Bank of America Global Research, both of whom had already forecasted a rate cut following surprisingly dovish comments from senior Fed officials.

The situation has become even more complex as the Fed grapples with its recently abandoned policy framework, rising public criticism, and an economy not responding to monetary policy in traditional ways.

Morgan Stanley: “We Jumped the Gun” on December Dilemma Forecast

Morgan Stanley reversed its December Dilemma outlook, admitting it “jumped the gun” as softer economic data and dovish Fed signals point toward a rate cut, intensifying uncertainty around the Federal Reserve’s policy direction.

Morgan Stanley’s decision to walk back its earlier prediction of “no December cut” is noteworthy. The firm stated:

“It seems we jumped the gun.”

The reversal stems from several recent developments:

1. Softer economic data in late November

Reports show:

Most significantly, inflation appears to be easing faster than anticipated.

2. Dovish remarks from key Fed officials

Statements by:

all pointed toward readiness for at least one more rate reduction.

3. Market expectations surged dramatically

According to the CME FedWatch Tool:

This is one of the highest consensus expectations seen in years.

Morgan Stanley’s updated forecast

This represents a more accelerated easing path than previously expected.

Powell’s Leadership Test: The End of a Policy Era

The second major blog highlights a deeper challenge facing the Fed: leadership credibility and the end of the Flexible Average Inflation Targeting (FAIT) framework.

What Happened to FAIT?

Introduced in August 2020, FAIT allowed inflation to run moderately above 2% for some time to support maximum employment.

But the policy backfired:

At Jackson Hole in 2025, Powell officially announced:

FAIT is over. The Fed is returning to a traditional dual-mandate approach.

December Meeting: The First Test of the New Framework

The big question:

Will the Fed cut rates even though inflation is still nearly 1% above target?

If yes, it suggests the Fed will:

If no, the Fed risks tightening financial conditions into a weakening economy.

Powell is under intense scrutiny, especially as President Trump prepares to nominate the next Fed Chair. His choice—widely speculated to be Kevin Hassett—could reshape the Fed’s independence.

A Divided FOMC: The Return of Non-Unanimous Votes

For years, FOMC decisions were nearly unanimous. That era is ending.

Powell has already warned:

“There are strongly differing views on how to proceed.”

Reports suggest:

This tactic was described as a way to end the “soap opera” of public disagreement within the Fed.

Interest Rate Cuts May Not Boost the Economy Much—Here’s Why

Bloomberg’s analysis shows a critical truth:
Even if the Fed cuts rates, the U.S. economy may not respond quickly.

Several structural issues limit the impact of cheaper borrowing.

Housing Market Still Too Expensive

Lower mortgage rates usually boost home sales.
But today’s market faces three major pressures:

Mortgage rates have fallen from their peak, but not enough to offset historically high property values.

Economist Michael Fratantoni summarizes:

“Even with lower rates, Americans remain cautious.”

Labor Market Anxiety Is High

Consumers are delaying large purchases like homes and cars because:

These fears reduce spending even when credit is cheaper.

Tariff Uncertainty Is Freezing Business Investment

One of the biggest unknowns:

As Kathy Bostjancic notes:

“Companies are pausing hiring—not because rates are high, but because policy uncertainty is high.”

This means rate cuts cannot fix the underlying hesitation.

Manufacturing Is Slumping—And Rates Aren’t the Problem

The U.S. manufacturing sector has shrunk for nine consecutive months.

Companies say:

are bigger issues than interest rates.

One ISM survey respondent said:

“Lower rates will not impact our business.”

This sentiment is widespread.

Consumers With Fixed-Rate Loans Don’t Benefit Immediately

Most existing debt—mortgages, student loans, auto loans—is fixed rate, meaning rate cuts only affect:

But many Americans:

Thus, rate cuts won’t significantly boost consumer spending right away.

Financial Markets Already “Price In” Cuts Before They Happen

Investors anticipate policy changes months in advance.
This means:

Thus, the December cut may offer limited new stimulus.

Research finds:

Who Benefits Most from Rate Cuts? The Wealthy.

This dynamic may worsen inequality if inflation remains elevated.

Morgan Stanley: Powell Will Trade the Cut for a Tougher Tone

Morgan Stanley expects:

This allows Powell to:

It’s a classic political-monetary compromise.

The Real Risk: Markets Doubt the Fed’s Inflation Commitment

If investors believe Powell is too soft on inflation, they may:

This happened in the 1970s and remains a key risk today.

The Fed’s Independence Is Under Threat

Trump’s upcoming Fed chair nomination adds political volatility.

Concerns include:

The December meeting will be interpreted through this political lens.

What Will the Fed Do in December? Most Likely: A Cut + a Warning

Based on all sources:

Most Probable Outcome:

✔ 25bp rate cut
✔ Statement signaling:

Why this outcome makes sense:

Powell’s challenge is balancing:

The December meeting will shape economic expectations for 2026 and beyond.

Conclusion: A Rate Cut Is Coming—But Relief May Be Limited

Based on all expert commentary and data:

The December decision is not just about interest rates—it’s about the Fed’s credibility, independence, and ability to manage a complex, post-pandemic economy facing multiple cross-currents.

Whatever Powell announces, it will set the tone for the U.S. economy in 2026.


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