We know a new Fed Chair is coming, are rate cuts too?
Key Takeaways
- Rate cuts are still uncertain and data-dependent: While markets see a 50/50 chance of a small cut in December, post-shutdown data may be noisy and inflation remains elevated, making it difficult for the Fed to justify easing without clearer economic signals.
- A more accommodative Fed stance is likely under new leadership: With five finalists who are generally more dovish than Chair Powell, the incoming Fed Chair in May 2026 could support gradual policy easing, though long-term rate dynamics remain a key consideration.
- Investment-grade fixed income remains attractive with disciplined positioning: A moderate duration approach and focus on strong credit quality is favored, while long-dated bonds and low-spread yield chasing are avoided to maintain prudent risk-adjusted outcomes.
Government Shutdown Impact and What It Means for Economic Data
With the government shutdown finally resolved, the regular flow of federal economic data should resume soon. While the Fed has numerous sources of economic data, government data is still important in shaping the Fed’s economic policy. ADP recently began releasing weekly payroll data, but as long-term market participants know, this data is extremely noisy and not reliable. As 2025 comes to an end, we remain focused on economic data, near-term Fed policy, and the ramifications of a new Fed Chair taking office in May 2026.
Mixed Consumer Spending Signals and the Fed’s Policy Considerations
We anticipate the economic data through November will be noisy given the government shutdown. The economy overall appears to be in a slow growth mode with significant tailwinds from AI investments. Middle and lower-income consumers are slowing their discretionary spending according to comments from several consumer companies. Even so, the wealth effect, especially from the rise in stock indexes, has helped keep higher income consumption robust, and these households account for much of consumer spending. We think the Fed is well aware of these dynamics and will continue to monitor the data closely. Unemployment remains relatively low at 4.3% through August (last available reading), and consumers, while pulling back a bit, do not seem overly fearful. The market currently forecasts a 50:50 chance of a 0.25% cut at the December meeting. We currently think the Fed is likely to hold rates steady in December given elevated inflation and the lack of economic data to justify a cut. If new economic data between now and December 10th shows weakness, however, the Fed will likely cut by 0.25%. If the economic data is stable or positive, the Fed may wait and see, but this ignores the likely political pressure to cut. For context, the current Fed Funds rate of 3.75-4.00% is above the range of longer-run estimates from 2.8-3.5%. We can assure you that the five remaining candidates for Fed Chair are supportive of more accommodative Fed policy.
Who Could Become the Next Fed Chair and What It Means for Rates
The nominee for Fed Chair is now narrowed down to five candidates. Three of the five finalists are current or former Fed governors in addition to National Economic Council Director Kevin Hassett and Blackrock Fixed Income executive Rick Rieder. While they will all be more publicly dovish than Powell currently is, we do expect some degree of prudence from them. To use an extreme example, taking the Fed Funds rate to 0% in an economy that is slowly growing and experiencing inflation of 3% would likely drive-up long-term Treasury bond yields. And it is long-term rates that influence the cost of mortgages, corporate borrowing, and some proportion of government debt. Trump will likely announce his candidate by year-end with the new Fed Chair assuming the role in May 2026. As of this commentary, the market expects approximately two 0.25% cuts through May 2026.
Portfolio Strategy Outlook: Duration, Risk, and Opportunity
Since we currently expect Fed policy to be neutral or dovish, we are maintaining a moderate duration and strong credit quality. We do not want to be too short and not benefit if Treasury rates were to decline due to an economic slowdown. In a status quo economic scenario, we do not think rates rise meaningfully with the 5-year Treasury of approximately 3.70% quite close to the current Fed Funds rate of 3.75-4.00%. Currently, we have little interest in adding very long-dated duration (20-30 years) bonds as the government debt continues to grow with no end in sight. Regarding risk premiums on bonds (credit spreads), they are extremely low and discipline dictates we do not chase yield in such an environment. In conclusion, we think investment grade fixed income yields are attractive, and we remain ready to take advantage of opportunities as they arise.
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