This year, Fed Chair Powell successfully bridged the internal divisions within the central bank to push through three interest rate cuts. However, if inflation remains persistently high while the job market stays weak, the incoming chair may find it more challenging to build consensus.
Over the past year, the Federal Reserve has found itself in a rare predicament not seen since the stagflation era of the 1970s while pursuing its dual mandate from Congress—maximum employment and price stability. This situation has sparked profound internal divisions within the Fed not witnessed in years, most visibly reflected in the sharply opposing views among committee members regarding interest rate policy.
This divisive trend is expected to persist until 2026.
Matthew Luzzetti, Chief U.S. Economist at Deutsche Bank, pointed out that Federal Reserve Chair Powell successfully bridged divisions within the central bank this year, paving the way for three rate cuts. However, if inflation remains persistently high while the labor market stays weak, the incoming chair may find it more challenging to forge consensus.
Luzzetti stated, "Although the most likely policy path ahead remains further rate cuts, we must remain alert to a risk scenario: the next chair may ultimately face a committee considering raising rates."
Ian Wyatt, Chief Economist at Huntington Bank, added, "In such an environment, reconciling differing opinions and driving policy consensus will undoubtedly be a formidable task for the new chair. Particularly when the incoming chair’s policy stance is significantly misaligned with the majority view of the committee, the difficulty will escalate further."
The Growing Influence of Trump
In early 2025, the Trump administration launched a series of intensive economic policy adjustments, ranging from fluctuating tariff rates to tightened border controls aimed at limiting immigration inflows. These measures kept the Federal Reserve in a prolonged state of policy观望 throughout most of the year. Officials had to expend significant effort assessing the potential impact of these policies on economic growth, inflation levels, and the labor market.
The Fed's passive stance displeased Trump greatly. On one hand, he continuously pressured the Fed to cut interest rates; on the other hand, he attacked Powell by seizing procedural details, attempting to remove him from office. The threat to dismiss Powell over policy disagreements raised concerns about the erosion of central bank independence, causing significant volatility in financial markets. Although Trump ultimately did not fire Powell, he removed Federal Reserve Governor Lisa Cook on allegations of mortgage fraud—the related case is still under judicial review, with the U.S. Supreme Court set to hear the case early next year.
Meanwhile, Federal Reserve Governor Adriana Kugler stepped down this summer. Trump promptly appointed Stephen Milan, Chair of the White House Council of Economic Advisers, to fill the remaining five months of her term. Notably, Milan did not resign from his White House position but instead took a temporary leave of absence. This move raised concerns among many Fed observers about potential damage to the central bank’s independence—Milan himself had previously warned about such risks before joining the government.
Tariff Shocks and Labor Market Weakness
Initially, most Federal Reserve officials believed that the impact of tariffs would merely result in a one-time price increase and would not evolve into long-term inflationary pressure. However, with the arrival of 'Tax Freedom Day' on April 2, the Trump administration introduced the largest and most comprehensive tariff policy in a century. As a result, an increasing number of Fed officials began to worry that tariffs might trigger persistent inflation issues.
To this end, the Federal Reserve spent the entire summer closely monitoring and assessing the actual impact of the tariff policy.
By July, signs of cooling had emerged in the U.S. labor market. The Federal Reserve held a monetary policy meeting and decided to keep interest rates unchanged—a stance consistent throughout the year. However, this decision faced opposition from Federal Reserve Governor Christopher Waller and Michelle Bowman, both of whom advocated for a rate cut as a precautionary measure to cushion the weakening job market. This dissenting voice clearly exposed deep divisions within the Fed: committee members held starkly different views on the stickiness of inflation and the extent to which policymaking should focus on the sluggish employment situation.
Toward the end of summer, employment market data revealed more severe problems than anticipated. This shift prompted Powell to lay the groundwork for a rate cut in September. This rate cut marked the beginning of three reductions in the fall, mirroring the policy rhythm of 2024.
In the same fall, the United States also experienced the longest government shutdown in its history. Due to the lack of officially released economic data, the Federal Reserve was left in a 'blind flight' quandary when formulating key interest rate decisions. Officials had to rely on private sector data, which, while adequately covering the labor market, offered limited reference value for inflation and price-related areas.
By December, the rifts within the Federal Reserve had become fully public. Although the Fed ultimately completed its third rate cut of the year that month, two voting members—Chicago Fed President Austin Goolsbee and Kansas City Fed President Jeff Schmid—explicitly opposed the move. Both cited concerns about inflation and advocated for maintaining unchanged interest rates. Meanwhile, Governor Milan also cast a dissenting vote but leaned toward a more substantial rate cut, advocating for a one-time reduction of 50 basis points. Additionally, six non-voting members expressed disapproval of implementing a rate cut that month.
Despite widespread market discussions about inflation risks triggered by tariffs, the actual impact of tariffs on inflation this year was lower than expected. Some Federal Reserve officials, including Powell and Waller, believe that inflationary pressures brought by tariffs will peak in the first quarter of next year before gradually subsiding. However, committee members such as Cleveland Fed President Beth Hammock and Dallas Fed President Lori Logan—who are both voting members of the Federal Reserve in 2026—hold differing views. They fear that inflation’s persistence may exceed expectations, potentially prolonging a high-inflation environment.
2026: Policymaking Proceeds with Caution
Against the backdrop of completing three so-called 'preventive rate cuts' and inflation levels still failing to retreat to the target range,the Federal Open Market Committeea clear signal has been sent: ample time will be reserved to observe and assess the economic situation before considering further rate cuts.
Despite the belated release of the latest economic data, the current economic landscape remains unclear due to distortions in statistical data caused by the government shutdown. The inability to accurately gauge the state of economic fundamentals has further complicated the Federal Reserve's policy forecasts and precision in policymaking.
The latest inflation report for November shows a significant narrowing in overall price increases as rental prices have declined and been incorporated into calculations. However, many market participants question the accuracy of this report due to data gaps resulting from the government shutdown.
New York Fed President John Williams stated that he believes the latest inflation data, calculated using the Consumer Price Index (CPI), underestimates actual inflation by 0.1 percentage points; Hammock, on the other hand, believes the underestimation may range between 0.2 to 0.3 percentage points. Meanwhile, the U.S. unemployment rate has risen slightly to 4.6%.
Looking ahead to 2026, Federal Reserve officials expect only one additional rate cut next year. Although the labor market continues to cool, policymakers believe this weakening trend has not yet reached a level requiring urgent intervention. At the same time, inflation remains above the 2% policy target. Officials predict that U.S. economic growth will pick up in 2026, driven by fiscal stimulus from the tax bill and the rebound effect following the end of the government shutdown.
Jeffrey Roach, Chief Economist at LPL Financial, stated that inflation data is expected to fluctuate in the coming months, but the overall inflation level for 2026 will trend downward, creating room for further interest rate cuts by the Federal Reserve.
He noted: "In early 2026, inflation data may rise several times as larger-than-expected tax refunds boost consumer demand, but inflation is expected to return to a cooling trajectory in the second half of next year."
Former Kansas City Fed President Esther George predicts that the unemployment rate will stabilize next year (albeit at a higher level). In light of large-scale fiscal deficit spending, ongoing concerns about the independence of the Federal Reserve, and accommodative financial conditions, inflation is expected to remain elevated.
George stated: "Due to disruptions in the release of official data, the Federal Open Market Committee’s policy actions in 2026 are likely to be cautious, but they will still maintain a bias toward rate cuts. The rationale behind these cuts is to guide the policy rate back toward a neutral level."
Additionally, 2026 will mark the first change in the Fed chairmanship in eight years. It is widely anticipated that the president will nominate a candidate inclined toward low-interest-rate policies for the position. Even so, if inflation remains persistently high, the new chair will face significant challenges in building consensus for further rate cuts. Cleveland Fed President Hammock has clearly indicated—as a voting member in 2026—that she advocates maintaining rates unchanged until the spring of next year.
Wilmer Stith, bond portfolio manager at Wilmington Trust, stated that divisions within the Fed are expected to persist in 2026. If the new chair attempts to push through rate cuts while facing clear opposition from other committee members, the likelihood of dissenting opinions during meetings may increase further.
He also predicted that the Trump administration would continue to pressure the Federal Reserve to pursue a lower interest rate policy.
However, Powell's term as chairman will last until May of next year. Stith noted that due to this factor, the Federal Reserve is expected to implement very limited interest rate cuts in the first half of 2026, with only one rate cut anticipated between January and May.
Stith stated, "I believe that once the new chairman takes office, there could be two to three rate cuts throughout the year. In the future, the Federal Reserve may become more closely aligned with the government’s policy stance for an extended period. From this perspective, a rate cut seems inevitable."
Editor/KOKO