Analysis-Investors warm up for long spell of discordant Fed

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By Vidya Ranganathan

LONDON, Dec 9 (Reuters) – What is expected to be one of the most ructious Federal Reserve policy meetings in years this week could well prove to be the road test for financial markets on how U.S. monetary policy debates will shape up in 2026.

Heading into the two-day meeting that began on Tuesday, markets are pricing in an almost certain chance of an interest rate cut by the U.S. central bank’s policy-setting Federal Open Market Committee, even though the group is the most divided it has been in years.

The weeks leading up to the meeting have been stressful for investors, with little data to parse during a record 43-day U.S. government shutdown, conflicting messages from Fed officials and the unrelenting push from President Donald Trump’s administration for lower rates.

Expectations that the Fed will reduce its benchmark overnight interest rate by a quarter of a percentage point to the 3.50-3.75% range have climbed to 87% from 30% in the past three weeks, spurred largely by New York Fed President John Williams’ recent support for an insurance rate cut. 

Investment banks Morgan Stanley, J.P. Morgan and BofA reacted by changing their calls to a cut at the December 9-10 meeting. 

Yet, analysts expect as many as five of the 12 voting members of the FOMC will have divergent views, reinforcing the refrain in markets that the Fed is turning more political.

The policy committee has not had three or more dissents at a meeting since 2019, and that has happened just nine times since 1990. Analysts now expect such dissent will persist.

“The more dissent that you see, and the more open it is, the more it does call into question about how willing the Fed is to become more politicized,” said Sally Greig, head of global bonds at Scottish long-only investment manager Baillie Gifford.

“It raises questions about how willing they are to keep life a little bit easier for them by erring on the side of being a bit too dovish rather than a bit too hawkish, how concerned they are for their own jobs.”

Trump’s appointees to the Fed’s seven-member Board of Governors have been dovish. His economic adviser Kevin Hassett, a top candidate to succeed Fed Chair Jerome Powell next year, has called for lower rates. Fed Governor Stephen Miran, another Trump economic adviser who was appointed in September to fill an unexpected board vacancy, has been pushing for oversized rate cuts.

Other FOMC members such as Kansas City Fed President Jeffrey Schmid, St. Louis Fed President Alberto Musalem and Fed Vice Chair Philip Jefferson, however, have been equally vocal about their preference to keep rates steady.

When Williams, normally a more neutral voice, was explicitly dovish about a December rate cut within weeks of Powell saying in October that a December cut was far from certain, more investors got twitchy about political pressure.

FOCUS ON POWELL’S SUCCESSOR

Even if the Fed cuts rates this week and signals it will hold them steady in January, “the market may not give that signal credence, given the 180-degree turnaround from the hawkish signals at the October meeting and minutes,” Standard Chartered Bank analysts Steve Englander and John Davies wrote this week.    

Traders pointed to rising volatility priced into short-term interest rate options and steepening long-term yields as a sign of such concern. 

“There’s more sensitivity now and people are having to decide whose comments you place weight on,” a bond trader in London said. 

Yet, barely 75 basis points of Fed easing is expected by the end of next year, according to rates futures markets.   

Fabio Bassi, head of cross-asset strategy at J.P. Morgan, says investors should not focus only on the December meeting.

“Powell’s Fed, which is in charge now, is not leaning towards very aggressive action, they are delivering insurance cuts.”

Trump, however, seems bent on lower borrowing costs ahead of the U.S. midterm elections late next year. The Republican president, who has voiced repeated displeasure with Powell’s stewardship of the Fed, said support for immediately cutting rates would be a requirement for anyone he chose to lead the central bank, according to a Politico interview published on Tuesday.

The Fed cut rates at its September and October meetings.

Trump’s attempt to fire Fed Governor Lisa Cook, who was appointed by former President Joe Biden, and recent comments by Treasury Secretary Scott Bessent about possible changes to how the Fed’s regional bank presidents are hired are also fueling more concerns about politicization of the central bank.

But how far that political pressure will influence the Fed isn’t clear.

“I understand why people are talking about it, but I don’t think it would be justified for it to be in the price at the moment, given what we know,” said James Athey, fixed income fund manager at London-based investment group Marlborough.

“I think it’s a risk. It’s not a reality.”

Tim Winstone, head of investment grade credit at Janus Henderson Investors, said some clients are rethinking options when allocating the marginal dollar and investing less in the U.S.

“It’s people just acknowledging that the risks to what the United States historically stood for are higher. And the evolving political landscape and the impact that has on the Fed is certainly a factor.”

(Additional reporting by Davide Barbuscia, Gertrude Chavez and Saqib Ahmed in New York; Editing by Paul Simao)