Fed fractures deepen, despite Powell's "Three and See" cut

The Fed’s latest rate cut was widely expected and pleased markets. But with inflation running a full 1% above target and policymaker dissent growing ahead of Chair Powell’s departure, fiscal strains and stubborn long-term rates are clouding the outlook.

11 December 2025

The US Federal Reserve (Fed) cut interest rates by 25 basis point (bps), to 3.5-3.75%, a move which clearly pleased markets with the S&P 500 Index up over 0.5% on Wednesday. That the response wasn’t even more positive was probably down to anticipation of Fed monetary policy loosening which had been building up for several weeks already. From the trough of November’s “AI bubble” wobble to 10 December (less than a month), the US large cap index has added a cool 5.4%. But investors shouldn’t become complacent at this point.

Starting with the Fed themselves, while this was the third meeting in a row in which they chose to cut rates, fully three members dissented from the vote this time. The broad direction will doubtless please the US administration, but it does leave the door open to further inflationary risks. US headline Consumer Price Index (CPI) inflation is already running warm at 3%*, which is 1% higher than the mandated target. That the Fed was so divided this time around therefore speaks to its sometimes-contradictory mandate of maintaining full employment but also controlling inflation. For Fed Chair Powell, the bar to further rate cuts is now high so it’s a case of “three and see” for him. But for the administration, which will determine the next Fed Chair, as well as participants such as the equality-minded John Williams, more is needed to support an economy showing signs of slowdown.

For markets, further gains from here will demand evidence of further loosening, but this alone may not be enough. Talk of an AI bubble may have been silenced for now by a strong Q3 earnings season – particularly for technology stocks – but the cost of capital across the economy remains an issue since longer-dated rates are not set by the Fed. Instead, they are set by bond markets which influence interest rates for longer-term borrowing such as mortgages and right now they are showing signs of discontent, not just in America but around the world. One major driver that has been making lenders reluctant to extend credit to governments, and therefore sent longer-dated yields higher, has been fiscal deficits. Governments around the developed world are stretched as demand for welfare rockets but the tax base diminishes. This makes governments, including America’s, a riskier credit, with the result that higher interest rates are logically demanded. The economy and the stockmarket may have scored a small victory on Wednesday with the Fed rate cut, but other factors could yet get in the way in the coming weeks and months.

Long-term rates also matter – and the Fed doesn’t directly control those:

From 31 Dec 2004 to 11 Dec 2025