Market Update 12/10/25: Fed Cuts Rates for Third Time – Implications for Markets and the Economy

Key Takeaways

• While we believe the current economic backdrop may be positive for stocks and bonds, we also anticipate a bumpier ride ahead, underscoring the importance of well-diversified portfolio allocations.
• The Fed appears to be approaching a wait-and-see mode, albeit with a downward bias for interest rates.
• Balancing act: the Fed wants to cut rates it considers still-restrictive amid a weakening labor market, but avoid the risk that rate cuts lead to rising inflation that is already elevated.
• In our view, the Fed remains more attentive to its employment mandate than its inflation mandate, and we expect a cautious approach to additional rate cuts.

Asset Class Implications

The current economic environment may be positive for stocks and bonds. With a backdrop of lower interest rates driven by easing Fed policy and stronger-than-anticipated economic growth, we are constructive on the outlook for U.S. stocks but cautious about concentration and stretched stock market valuations. As a result, we expect positive, but more moderate, stock market returns in the years ahead relative to the very strong performance experienced over the last three years.

Many of our preferred bond funds are currently yielding mid- to high single digits, and returns may be supported by the economic backdrop and a Fed oriented towards lower interest rates, albeit on a slower path. We particularly like alternative investments, and believe investments in private equity, real assets, and private credit may provide enhanced risk-adjusted returns and diversification beyond public markets.

Contentious Cut

The Fed chose to cut rates for the third consecutive meeting, bringing the target range for the federal funds rate to 3.50-3.75%. While the market had anticipated this rate cut – the market implied probability of a rate cut was approximately 90% in the days leading into the announcement – the decision was nonetheless not an easy one, and likely contentious internally at the Fed, as evidenced by three dissenting votes (one to cut rates further, and two who preferred no change at this meeting).

Threading a Needle

Current Fed policy is a balancing act. On the one hand, the Fed wants to cut interest rates it considers still-restrictive amid a weakening labor market. On the other hand, the Fed wants to avoid the risk that rate cuts further stimulate inflation or lead to rising inflationary expectations, especially at a time when economic growth has been better than anticipated, and inflation has risen on the back of tariffs.

The statement highlighted this challenge, noting that “downside risks to employment rose in recent months” due to a moderation in the labor market, with job gains slowing and the unemployment rate rising. At the same time, the statement noted that inflation has moved higher and remains elevated, while economic activity has expanded “at a moderate pace.” At his press conference, Chair Powell further underscored the Fed’s challenge, indicating that near-term risks to inflation are tilted to the upside, while near-term risks to employment are to the downside. As he put it, the Fed has one tool; it cannot do two things at once.

Approaching Wait-and-See Mode

It appears the Fed is approaching wait-and-see mode, albeit with a downward bias for interest rates. Powell indicated that after today’s cut, the fed funds rate is within range of neutral policy, and the Fed is well positioned to “wait and see how the economy evolves from here.”

In our view, the Fed remains more attentive to its employment mandate than its inflation mandate. While the economy has performed better than anticipated, the area of the economy that is clearly weakening is the labor market. The Fed is closely monitoring the labor market due to potential spillover effects on consumer spending, given that consumer spending is the most important component of U.S. GDP (making up approximately 70% of total GDP). At the same time, despite elevated headline inflation, Powell indicated the Fed anticipates the inflationary impact of tariffs is likely to result in a one-time boost to the price level and be relatively short-lived. As a result, we anticipate the Fed will maintain a bias towards lowering rates, albeit at a slower pace.