Fed Rate-Cut Compass: Cooling Inflation and Labor Market Challenges

By ariachiang

2026-01-09

The U.S. Federal Reserve’s benchmark interest rate is currently maintained at a range of 3.50% to 3.75%, down approximately 15.9 basis points year over year from 4.33%, marking a relatively low level in recent years. Inflation rose 2.7% year over year in December 2025, the lowest since July and below the market expectation of 3.1%. On the labor front, ADP private-sector employment increased by only 41,000 in December. Although this represented a rebound from a revised loss of 29,000 in the previous month, it remained well below the market forecast of 50,000. The unemployment rate held steady at 4.6%, a four-year high.

The easing in inflation primarily reflects core inflation of around 2.3%, indicating that the Federal Reserve’s monetary policy has been effective in curbing price pressures, despite energy prices still rising 4.2% year over year. Labor market weakness stems from a pronounced slowdown in hiring and increased layoffs in the second half of 2025. According to ADP data, planned hiring declined 34% year over year, the lowest level since 2010. Fed Governor Milan noted that overly tight monetary policy has constrained economic growth and therefore advocated for a cumulative 150-basis-point rate cut in 2026 to support employment.

In the short term, the probability of a rate cut at the Federal Reserve’s January 27–28 meeting stands at only 11.6%. While the median projection among Fed officials points to a single rate cut, investors are pricing in at least two cuts. Over the medium term, if labor data remain weak and inflation stays near 2%, total rate cuts in 2026 are expected to reach 100 to 150 basis points, potentially bringing the benchmark rate down to around 3.4%. Overall market sentiment remains optimistic, though risks include potential data distortions from a government shutdown and policy uncertainties associated with the Trump administration.

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