Federal Reserve Monetary Policy Shift: Liquidity Injection and Economic Outlook for 2026

Key Points

• FOMC Meeting Decision Deep Dive: The Significance of Rate Cuts and Dissenting Views

• Dual Pressures of Inflation and the Labor Market

• Market Immediate Response: Risk Assets Rebound and Bond Adjustments

• 2026 Monetary Policy Outlook: Cautious Easing and Personnel Changes

• Economic Outlook: K-Shaped Divergence and Trade Frictions

• Global Impact and Market Insights

On December 10, 2025, the U.S. Federal Open Market Committee (FOMC) announced at its final meeting of the year that the target range for the federal funds rate would be lowered by 25 basis points to 3.50%-3.75%. This is the third rate cut of the year, totaling 75 basis points since September. While the decision aligned with market expectations, internal disagreements were prominent, with 9 votes in favor and 3 against, the highest dissent since September 2019. The meeting also announced that, effective December 12, the Fed would resume Treasury bond purchases, initially at a scale of $40 billion per month to maintain ample reserves. This marks the end of quantitative tightening (QT) and the restart of balance sheet expansion. Although officials emphasize this is not quantitative easing (QE), in practice it will inject liquidity, impacting financial markets and the real economy.

The context of this meeting is complex: the U.S. economy in 2025 faces multiple challenges, including government shutdown-related data delays, simultaneous inflation pressures and labor market slowdown, and uncertainty surrounding tariffs under the Trump administration. Fed Chair Jerome Powell stated at the press conference that economic activity is expanding at a moderate pace, the labor market remains solid but with unemployment at 4.4%, and inflation is “slightly above expectations.” He emphasized that policy aims to balance employment and price stability, but future adjustments will “carefully assess data, outlook developments, and risks.” This stance was interpreted by markets as “hawkish rate cuts”—short-term support for growth but cautious about further easing in 2026.

Deep Dive into the FOMC Decision: The Underlying Meaning of Rate Cuts and Dissent

The FOMC’s rate cut path is rooted in the economic dynamics of 2025. According to the Fed’s Summary of Economic Projections (SEP), 2025 GDP growth is expected at 1.7%, with a median unemployment rate of 4.5% and core PCE inflation at 3.0%. These figures are unchanged from the September meeting, but the dot plot indicates only one 25 basis point rate cut expected in 2026, another in 2027, approaching a long-term neutral rate of around 3%. Seven officials anticipate no cuts in 2026, with one hinting at possible rate hikes, reflecting concerns over inflation risks.

The increase in dissenting votes is a key focus. Opponents to rate cuts include Chicago Fed President Austan Goolsbee and Kansas City Fed President Jeffrey Schmid, who believe current policy is sufficiently accommodative; Fed Governor Stephen Miran, supporting a 50 basis point cut, worries about downside risks to the labor market. Powell responded that these dissenting views are “constructive discussions,” but acknowledged the decision was “very close,” highlighting the committee’s trade-off between inflation and employment. Historically, since 1990, the FOMC has only had nine instances with three or more dissenting votes, often signaling increased policy uncertainty.

Additionally, the measures announced following the end of QT have attracted attention. Since June 2022, the balance sheet has shrunk from a peak of $8.5 trillion to $6.25 trillion. Recently, monetary market pressures have increased, with repo rates fluctuating more sharply. The Fed judged that reserves are now “slightly above sufficient levels,” leading to the decision to halt reinvestment of maturing securities starting December 1 and to begin Treasury purchases on December 12, focusing on short-term treasuries within three years of maturity, initially at $40 billion per month, with adjustments as needed. This is viewed as “QE-lite,” aiming to stabilize liquidity rather than stimulate growth. Officials emphasize this move avoids repeating the 2019 reserve shortage, but markets worry it may reignite asset price inflation.

Inflation and the Labor Market: Dual Pressures

U.S. inflation in 2025 has shown a complex trajectory. The September CPI annual rate rose to 3.0%, slightly up from 2.9% in August, with core CPI also at 3.0%. The Cleveland Fed’s “real inflation” measure—excluding volatile items—reported at 2.51% earlier in December, indicating easing core pressures. However, rebounds in energy prices (gasoline down 0.5% annually but fuel oil up 4.1%) and tariff pass-through effects add uncertainty. Powell noted that, excluding tariffs, inflation has already fallen to “around 2%,” but emphasized tariffs could cause “transient” price increases, and the Fed will ensure they do not embed into inflation expectations.

The labor market is a primary reason for rate cuts. October non-farm payrolls slowed, unemployment remained steady at 4.4%, but job openings fell to their lowest since early 2021, and quits dropped to the lowest since early 2021 (1.8%). Hiring rates stalled at 3.2%, indicating a “low hiring, low quitting” pattern. SEP projects that unemployment will slightly decline to 4.4% in 2026, but downside risks are rising. Data delays caused by the government shutdown further cloud the outlook. Powell stated that “significant downside risks” in the employment market prompted this rate cut, but if growth remains resilient, the Fed may pause.

Tariff policies amplify these pressures. The Trump administration in 2025 reintroduced multiple rounds of tariffs, including 25% tariffs on vehicles from Canada and Mexico, and tariffs ranging from 10% to 60% on Chinese goods. The IMF estimates that a 10% across-the-board tariff combined with retaliatory measures could reduce U.S. GDP in 2026 by 1% and slow global growth by 0.5%. J.P. Morgan research indicates tariffs have already increased costs for businesses, passed through to consumers, and are expected to push core PCE inflation to 2.5%-2.6% in 2026. While Powell downplays their long-term impact, he admits the “short-term shocks are significant,” aligning with the Fed’s “risk-neutral path” rhetoric.

Market Immediate Reaction: Risk Assets Rebound and Bond Adjustments

Following the meeting, U.S. stocks quickly rebounded, with the Dow Jones rising 500 points, the S&P 500 gaining 0.5%, and the Nasdaq up 0.3%. The 10-year Treasury yield dropped from 4.20% to 4.14%, reflecting increased liquidity expectations. Gold rose 0.5% to $4,200 per ounce, while Bitcoin saw a modest dip but overall risk appetite improved. Crypto markets view this as a “liquidity catalyst,” with discussions on X (formerly Twitter) suggesting traders anticipate fund inflows into high-risk assets like meme coins and AI-related stocks.

Bond markets responded mildly but with underlying concerns. The short-term yield curve flattened, indicating market welcome for Fed purchases; the long end remains cautious about inflation. The prediction market Kalshi shows a 72% chance of Kevin Hassett becoming Fed Chair, higher than Kevin Warsh at 13% and Christopher Waller at 8%. Hassett is seen as more dovish, potentially accelerating 2026 easing and pushing yields lower.

2026 Monetary Policy Outlook: Cautious Easing and Personnel Changes

Looking ahead to 2026, Fed policy will be data-dependent, but disagreements may persist. The dot plot suggests only one rate cut throughout the year, with Powell’s term ending in May, and a new Chair nominated by Trump could reshape policy. If Hassett takes office, more easing might support growth, but inflation risks will need balancing. Deloitte predicts that if tariffs persist, U.S. GDP could grow only 0.8% in 2026; in an optimistic scenario, AI investments could boost growth to 2.3%.

Balance sheet expansion remains a key variable. If the Fed continues buying $40 billion of assets monthly, the balance sheet could reach over $6.5 trillion in 2026. Analysts like Lyn Alden see this as “monetary expansion in essence,” even if not traditional QE, amplifying liquidity effects. Market consensus via X suggests “money printing restarted,” but warns that excessive optimism could lead to volatility.

Personnel changes add further uncertainty. Trump has indicated “nomination imminent,” but delays continue. A CNBC Fed survey shows 84% expect Hassett to be appointed, but only 5% see him as the top choice, citing concerns over Fed independence. If Waller remains, policy might stay neutral; Warsh is more hawkish. Regardless of who is appointed, political pressures will test the Fed’s credibility.

Economic Outlook: K-Shaped Divergence and Trade Frictions

In 2026, the U.S. economy is expected to recover modestly, with GDP growth between 1.8% and 2.3%, higher than 2025’s 1.7%. Consumer spending remains steady, but K-shaped divergence intensifies: high-income groups drive retail (early signs from Christmas shopping data), while middle and lower-income segments face utility defaults and rising food prices. Morgan Stanley forecasts AI investments will boost productivity, but immigration restrictions and tariffs will hinder labor supply.

Trade tensions are the biggest risk. Tariffs have led to supply chain reshuffling, with China re-exporting through third countries to evade tariffs. However, renegotiations of USMCA in 2026 could trigger new frictions. RBC Economics warns tariffs could reduce employment slightly and cause a “mild stagflation,” with growth below 2% and inflation above 2%. The IMF raised the U.S. outlook to 1.7% but cautioned about retaliation risks. Optimistic factors include the shift of $8 trillion in currency funds into dividend-paying stocks seeking higher yields.

Global Impact and Market Insights

The Fed’s shift toward easing will have spillover effects worldwide. Emerging markets will benefit from a weaker dollar, but the ECB and BoJ may follow suit with rate cuts. Crypto assets could benefit from liquidity flows, with X semantic searches indicating traders see T-bill purchases as “hidden QE,” expecting Bitcoin and others to rebound.

Overall, the December 2025 meeting marks a transition for the Fed from tightening to supportive policies, but dissent and uncertainty foreshadow volatility in 2026. Investors should monitor economic data releases (such as December 17 non-farm payrolls) and personnel announcements, balancing risk asset allocations. While the economy remains resilient, tariffs and divergence could challenge the recovery path.