Federal Reserve cuts interest rates 0.25% and increases growth projections for 2026

The Federal Reserve (Fed) lowered its target federal funds interest rate by 0.25%, setting the new range at 3.50%-3.75%. Investors anticipated this move, and most voting members supported it, though three dissented — one favored a 0.50% cut while two preferred no change. The Fed committee members’ updated projections now point to stronger economic growth and lower inflation forecasts for 2026 relative to September, with a median expectation of one rate cut in next year, while investors expect two.

Chairman Jerome Powell, whose term expires in May 2026, emphasized that future policy decisions will be data dependent, reinforcing his earlier message in November that the path forward is “far from” a foregone conclusion. The Fed previously cut rates 1% in 2024’s second half and 0.75% in 2025’s second half.

Fed raises growth outlook, signals higher bar for rate cuts

Policy rates had been somewhat restrictive, meaning high enough to moderate economic activity and reduce inflation. Softer labor market data contributed to recent policy rate reductions. Powell highlighted today that recent interest rate adjustments, “bring our policy within a broad range of estimates of neutral,” indicating the Committee perceives a higher bar for additional rate cuts in coming months.

Economic projections show stronger growth, lower inflation

The Fed’s official statement changed little compared to the October statement, but its updated Summary of Economic Projections highlights growing optimism around the economic outlook. Members’ median economic growth projection in 2026 rose to 2.3%, up from September’s 1.8% median. Core personal consumption expenditures (core PCE) projections, the Fed’s preferred inflation gauge, fell to 2.5% in 2026 from 2.6%. Unemployment rate projections for 2026 remained at 4.4%, consistent with recent readings.

Aggressive rate hikes from early 2022 to mid-2023 helped bring Core PCE inflation down from a peak above 5.5% year-over-year in 2022 to 2.8% by August. During the press conference, Powell said, “Inflation from core goods should peak in the first quarter” from tariff impacts, with inflation easing in the back half of 2026. We anticipate shelter costs, which comprise a large share of inflation indexes, should continue decelerating, allowing for additional rate cuts in 2026.

Federal Reserve ends balance sheet reduction, begins Treasury purchases

On December 1, the Fed stopped shrinking its $6.2 trillion in current bond holdings, which peaked at $8.5 trillion in 2022 before they allowed some bonds to mature without replacement each month through November 2025. The Fed will now buy short-term Treasury bills to ensure ample banking system reserves and keep short-term interest rates near its intended policy rate. Fed balance sheet expansion via announced Treasury bill purchases improves market liquidity, since investors will not need to absorb the incremental supply of bonds. Liquidity refers to the amount of money readily available to buy goods, services and financial assets in an economy. Strong liquidity can also provide cushion against unforeseen financial market shocks, and liquidity measures remain constructive for now.

Markets rise on Fed decision and economic outlook

Stocks and bonds responded positively to the Fed’s decision. Large stocks, represented by the S&P 500, rose 0.67%. Small stocks, which can be more sensitive to interest rates, rose 1.3%, represented by the Russell 2000 Index. Ten-year Treasury bond yields fell 0.04% to 4.15%, while two-year Treasury yields fell 0.07% to 3.54%.

Globally, central banks have eased policy this year: the European Central Bank and the Bank of Canada cut rates by 1.00%, while the Bank of England and Reserve Bank of Australia cut by 0.75%.

We maintain a constructive outlook for diversified portfolios, with opportunities in growth-oriented allocations including globally diversified stocks, global infrastructure and structured credit. Consumer spending and corporate earnings growth remain resilient, aided by lower policy interest rates and supportive fiscal policy in the form of lower corporate and individual taxes. Modest tariff-related price increases remain a factor, albeit less than many economists anticipated. Labor markets have softened in recent months, increasing the importance of monitoring metrics including job creation and layoff announcements. We will keep you informed of our views as new data becomes available and as we update our assessment of market conditions.

As always, we value your trust and are here to help in any way we can. Please do not hesitate to let us know if we can help address your unique financial situation or be of assistance.

View PDF version

This information represents the opinion of U.S. Bank Wealth Management. The views are subject to change at any time based on market or other conditions and are current as of the date indicated on the materials. This is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. U.S. Bank is not affiliated or associated with any organizations mentioned.

Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Diversification and asset allocation do not guarantee returns or protect against losses.

Past performance is no guarantee of future results. All performance data, while obtained from sources deemed to be reliable, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for direct investment. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index and is representative of the U.S. small capitalization securities market. The Personal Consumption Expenditures (PCE) Price Index is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. It is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.

Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. Investments in high yield bonds offer the potential for high current income and attractive total return, but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a bond issuer's ability to make principal and interest payments. The municipal bond market is volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issues of municipal securities. Interest rate increases can cause the price of a bond to decrease. Income on municipal bonds is free from federal taxes, but may be subject to the federal alternative minimum tax (AMT), state and local taxes. There are special risks associated with investments in real assets such as commodities and real estate securities. For commodities, risks may include market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults).

U.S. Bank and its representatives do not provide tax or legal advice. Your tax and financial situation is unique. You should consult your tax and/or legal advisor for advice and information concerning your particular situation.