Data Flashes - US

The Fed opted not to surprise markets at its December meeting and instead delivered a widely expected 25-basis point cut. The real value of this meeting wasn’t the rate cut itself, it was the diagnostic read it provided on underlying economic conditions. We are still working with incomplete data, but from our view, employment remains soft, inflation continues to challenge expectations, and consumers are becoming progressively less responsive to interest rate adjustments. The critical unknown is how tariff policies will look like in 2026.

While opposing dissents in the October meeting reflected a foggy outlook amid the government shutdown, the uptick in dissents in today’s meeting is reflective of a growing debate within the Fed – which side of the mandate is at risk of moving further away from target? The rise in the unemployment rate to 4.4% was enough to tip the scales in favor of the doves at this meeting, but as we head into 2026, our concerns are shifting toward the inflation backdrop. The full extent of tariff impact on inflation has yet to be felt and the delayed release of government data (and in some cases, a data void) continues to limit visibility into inflation’s trajectory. But today, Powell framed the decision around labor concerns:

“So, why do we move today? I would say, point to a couple things. First of all, gradual cooling in the labor market has continued. Unemployment is now up three-tenths from June through September. Payroll jobs are averaging 40,000 per month since April. We think there is an overstatement in these numbers by 60,000, so that would be -20,000 per month. And also, to point out one other thing, surveys of households and businesses both showed decline in supply and demand for workers, so I think you could say the labor market has continued to cool gradually, maybe a touch more gradual than we thought.”

Fog is still obscuring the Fed’s visibility into the macro backdrop

The Fed continues to operate in an environment with limited visibility following the government shutdown and delayed data releases. Chair Powell acknowledged this today, highlighting  the challenges interpreting the upcoming data releases:

 “There are very technical reasons about the way data are collected in some of these measures, both in inflation and in labor…so that the data may be distorted, and not just sort of more volatile, but distorted.”

 To be sure, visibility should continue to improve ahead of the January meeting. We will get more data on inflation, labor, and the broader economic backdrop.  We expect payroll data for both October and November to track closely in-line with our breakeven estimate for employment (around 40k per month). But we won’t get the unemployment rate for October, which will limit insights into the breakeven rate of payroll gains. Inflation and tariff pressures will likely be more challenging to assess because we will not get October CPI data and PPI data has been delayed until January. Importantly, Powell continued to stress that their views of inflation are more modest than ours – the SEP suggests the Fed expects tariff pressure will be modest next year, reflected by a downward shift in their core PCE forecast for 2026.

“There is no risk-free path for policy as we navigate this tension between our employment and inflation goals. A reasonable-based case is the effects of tariffs on inflation will be relatively short lived, effectively a one-time shift in the price level. Our obligation is to ensure a one-time increase in the price level does not become an ongoing inflation problem but with downside risks to employment risen in recent months the balance of risks has shifted.”

Absent a notable acceleration of inflationary pressures in the December data, we expect a window will remain open for the Fed to deliver one more 25bp cut early next year. But we expect the Fed likely has a limited window as the labor market shows continued signs of stabilization. Nonetheless, we continue to view the January meeting as data dependent.

The Fed has entered ‘neutral’ territory, so where do they go from here?

The rate decision itself was perhaps the least interesting part of today’s meeting. What was more noteworthy was the Fed’s stable economic outlook for 2026 and a dot plot that suggests only one more 25bp cut next year. This reflects a Fed that has, by its own estimation, reached a neutral level for interest rates.

“Having reduced our policy rate by 75 basis points since September, and 175 basis points since last September, the Fed funds rate is now within a broad range of estimates of its neutral value and well positioned to wait to see how the economy evolves.”

The median dot plot in the SEP maintained 25 basis points worth of cuts in 2026.  As it stands, there’s a narrow window in play during which growth and employment are weakening; inflation is softening in a way that permits rate cuts. If there’s a bias towards cuts (and there clearly is), now is the time to act. But we think that window likely closes by Q2 next year as inflation heats up and the labor market stabilizes.

Monetary policy will have limited impact on the economy in 2026

The question is – what is this trying to achieve, and how effective will it be? Today’s rate cut matters far less to the US economy than many might think. Another 25bps at the front-end will do effectively nothing to help mortgage payments and is unlikely to squeeze much growth out of the low-end consumer that is already stretched thin on spending.

On the one hand, government spending à la OBBB will be supportive of consumers and labor next year. On the other hand, monetary policy will do little to combat tariff pressures. While the big question now is the timing of a (potential) last cut, in our view, this does not matter for a few reasons.

Firstly, both market participants and forecasters alike have already baked in at least one additional cut, so it has little impact on financial conditions.

Second, it is questionable whether a slight adjustment lower in the Fed Funds rate will meaningfully boost demand – we do not expect that it will. Lower interest rates may help debt-ridden low-income consumers; however, we expect that they have already maxed out their purchasing power. Housing remains a significant hurdle for younger consumers and a slightly lower Fed Funds rate will do little to alleviate pressure in long end rates. Higher income earners – who have been driving the bulk of consumer spending in the US – are much less interest rate sensitive. In fact, we argue that fiscal policy (in the form of tax bracket adjustments and higher SALT cap deductions) will likely do more to boost consumer spending than lower interest rates will in 2026.  

Ultimately, if a partial tariff passthrough results in narrowed margins and consequentially, layoffs, monetary policy can do little to resolve a policy-induced price level shock.

Powell has said many times that “there is no risk-free path.” But the risks are going to become more asymmetric towards inflation in 2026. And as more FOMC voters dissent, the more likely an extended pause is the next decision for the Fed.

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About the Authors

Mike Reid is a Senior U.S. Economist at RBC. He is responsible for generating RBC’s U.S. economic outlook, providing commentary on macro indicators, and producing written analysis around the economic backdrop.

Carrie Freestone is an economist and a member of the macroeconomic analysis group. She is responsible for examining key economic trends including consumer spending, labour markets, GDP, and inflation.

Imri Haggin is an economist at RBC Capital Markets, where he focuses on thematic research. His prior work has centered on consumer credit dynamics and treasury modeling, with an emphasis on leveraging data to understand behavior.

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