CICC: The Fed is expected to cut interest rates twice in 2026, but the pace of interest rate cuts is slowing down

The Zhitong Finance App learned that CICC released a research report saying that the Federal Reserve cut interest rates by 25 basis points as expected at the December meeting, but the number of officials opposed to interest rate cuts increased to 2, indicating that the threshold for further interest rate cuts is being raised. Meanwhile, Powell's statement was not strong. Coupled with the Federal Reserve's announcement that it would launch a short-term treasury bill (T-bills) purchase operation, helped ease market concerns. Expectations of “hawkish interest rate cuts”, which had previously been fully taken into account, have been reversed, increasing market volatility. Looking ahead, given that the economy and employment are still facing downward pressure, the bank expects that the Fed may continue to cut interest rates in 2026; however, considering the persistence of inflation, the pace of interest rate cuts tends to slow down. The military may stand still in January, and the next rate cut may be in March.

CICC's main views are as follows:

The Federal Reserve cut interest rates as scheduled, and two officials opposed cutting interest rates. As expected by the market, the Federal Reserve cut interest rates by 25 basis points again in December. There was no consensus on this decision. Three officials put forward different opinions. Kansas Federal Reserve Chairman Schmid and Chicago Federal Reserve Chairman Goulsby think they should stay on hold, while Federal Reserve Governor Milan continues to believe that interest rates should be cut by 50 basis points. Compared with the previous meeting, the number of people who think interest rates should not continue to be cut has increased to two. This shows that differences within the Federal Reserve have intensified over whether interest rate cuts are necessary.

Interest rate cuts may continue next year, but short-term resistance will increase. Looking ahead, the real concern of the market is whether the Federal Reserve can continue to cut interest rates in 2026. According to the newly released interest rate bitmap, a total of 12 officials believe interest rates should continue to be cut, 1 more than at the previous meeting. 7 other officials prefer not to cut interest rates. 3 of them even predicted that interest rates would be raised. This makes the number of interest rate cuts next year shown in the bitmap still at once, in line with the previous meeting. In response to a reporter's question about whether interest rate cuts will be “suspended,” Federal Reserve Chairman Powell said that after the current interest rate cut to 3.5%-3.75%, the federal funds rate has entered the broad estimated range of neutral interest rates (bring our policy within a broad range of neutral interest rates), and the Federal Reserve will watch and adapt to subsequent economic trends at any time.

In other words, although the US job market has continued to slow since the last meeting, officials don't seem to be in a hurry to implement more easing policies. This means that the threshold for the next rate cut will be higher. There may be two reasons behind this: First, the latest inflation data is still stubborn and has not converged to the Federal Reserve's 2% target. Second, these officials believe that next year's economic growth may pick up from this year's, so there is no need for too much monetary easing. According to previously released economic forecasts, the forecast for 2026 GDP growth was raised to 2.3% from 1.7% in the previous meeting.

However, Powell downplayed these views at the press conference. He believes that current inflation is mainly concentrated in the tariff area, and inflation other than tariffs is still moderate; the recovery in economic growth next year is mainly due to a temporary slowdown in economic activity due to the government shutdown in the fourth quarter, and this increase will be compensated for in the first quarter of next year. He also mentioned that the non-farm payrolls data for the past few months may be overestimated, the actual employment situation may be weaker, and the increase in productivity brought about by artificial intelligence will also help curb inflation. Overall, Powell's attitude was not tough, which helped ease market concerns.

On the balance sheet side, the Federal Reserve has also made adjustments: in order to maintain sufficient reserves, the Federal Reserve will begin purchasing short-term treasury bills (T-bills), increase purchases by 40 billion US dollars this month, maintain a high scale in the coming months, and the subsequent scale will decline depending on market conditions. Powell said that this operation is only to support the effective implementation of monetary policy and the smooth operation of the market. It has nothing to do with the monetary policy stance. Maintaining purchases for several months is partly to avoid excessive liquidity constraints during the tax payment period in April next year. Despite this, re-expanding the balance sheet helps prevent liquidity risk, which is interpreted by the market as dovish.

Risk assets generally rose after the interest rate decision was announced, US bond yields fell, and the US dollar fell. One explanation is that the market had already fully priced “hawkish interest rate cuts” before the meeting, and Powell's attitude was not hawkish enough today. Coupled with the expansion of the Federal Reserve's statement, it brought about a reversal of expectations.

Regarding the future interest rate path, the bank maintained its previous judgment. The Federal Reserve may cut interest rates twice in 2026, but the pace is slowing down. January may stand still, and the next rate cut may be in March. Interest rate cuts continue because economic growth is still under pressure. On the one hand, the risk of supply contraction due to tariffs and immigration policies is still accumulating; on the other hand, the growth rate of AI-related investment may slow down, while slowing employment may drag down consumption, putting pressure on aggregate demand as well. In this context, if interest rate cuts reflect more of a decline in confidence in the economic outlook, then their supporting effect on the market is not necessarily significant.