Federal Reserve Rate Cut Expectations Fade Following December 2025 Employment Data

The December 2025 employment report, released on January 9, 2026, has fundamentally reshaped market expectations regarding Federal Reserve monetary policy. The U.S. economy added only 50,000 nonfarm payrolls during the month, falling below economist forecasts of 55,000 to 73,000, while the unemployment rate unexpectedly declined to 4.4% from a revised 4.5% in November [2][4]. This combination of below-forecast job creation alongside an improving unemployment rate created a nuanced data environment that complicated the Federal Reserve’s policy calculus.

According to Lindsay Rosner, Goldman Sachs Asset Management Head of Multi-Sector Fixed Income Investing, who appeared on Bloomberg’s “Real Yield” program, the December data effectively eliminated the possibility of a January rate cut [1]. Rosner noted that the unemployment rate improvement suggested November’s spike was attributable to “DOGE-deferred resignations and data distortions” rather than systemic labor market weakness. The Goldman Sachs perspective maintains that the Federal Reserve will remain on hold in the near term while still penciling in two rate cuts for the remainder of 2026 [1][3].

CME FedWatch data reflected this dramatic shift in market expectations, with traders reducing January rate cut odds to approximately 5%, down from 11-14% prior to the report [2]. The January 28-29 FOMC meeting now carries a 97% probability of an unchanged federal funds rate, with the March meeting showing less than 30% probability of a cut [3]. This rapid repricing underscores the market’s sensitivity to labor market indicators and its interpretation of the December data as inconsistent with urgent policy easing requirements.

U.S. equity markets responded positively to the employment data, with investors interpreting the mixed labor figures as supportive of a “soft landing” scenario rather than an economy requiring immediate Federal Reserve intervention [7][8]. The S&P 500 advanced 0.66% to close at 6,973.41, while the NASDAQ Composite rose 0.85% to 23,696.48. The Dow Jones Industrial Average gained 0.59% to 49,527.62, and the Russell 2000 added 0.43% to finish at 2,625.87 [7].

This market reaction reveals important investor psychology around the December employment report. Despite reduced rate cut expectations, which typically would weigh on rate-sensitive sectors, equities rallied on confidence that the labor market remains sufficiently resilient to avoid immediate economic distress while not being so strong as to force the Federal Reserve to maintain restrictive policy indefinitely. The three-month moving average of payrolls, now showing a negative 22,000 jobs per month, represents a concerning trend that market participants appear to be discounting as transitional rather than indicative of imminent recession [3].

Bond market reactions to the December employment report demonstrated the complex interplay between rate expectations and longer-term economic outlooks [2][4]. The 2-year Treasury yield rose approximately 5 basis points, reaching levels near 2026 highs around 3.54%, as diminished January rate cut odds triggered selling pressure in short-dated maturities. Conversely, the 10-year Treasury yield declined 1.2 basis points to approximately 4.17%, while the 30-year bond fell 1 basis point to around 4.85% [4].

This divergence between short and long-dated Treasury yields produced a modest steepening of the yield curve, reflecting market expectations that any economic weakness from labor market softening will be contained and unlikely to trigger aggressive Federal Reserve easing in the near term. The Dollar Index gained 0.28% to 99.16 following the jobs report, as reduced rate cut expectations enhanced the currency’s relative yield attractiveness [8].

Simultaneously influencing market dynamics, President Trump’s announcement that Fannie Mae and Freddie Mac would purchase $200 billion in mortgage-backed securities introduced an additional variable into the rate and housing market equation [6]. According to analysis from multiple sources, this initiative could reduce mortgage rates by an estimated 10-15 basis points, though analysts caution that the scale is modest compared to historical quantitative easing programs—representing approximately one-tenth the monthly pace of Federal Reserve QE purchases [6].

The mortgage-backed securities market rallied following the announcement, with spreads tightening relative to Treasuries as investors anticipated increased demand from the government-sponsored enterprises [1]. This policy intervention represents an alternative approach to rate relief, operating through credit market channels rather than traditional monetary policy adjustments.

The December 2025 report capped what Principal Asset Management characterized as “one of the worst years for hiring” in recent memory [5]. The calendar year saw just 584,000 jobs added—the weakest annual job growth since 2003—compared to approximately 2 million positions created in 2024 [3][5]. This deceleration represents a meaningful shift in labor market dynamics that the Federal Reserve must weigh against ongoing inflation pressures.

Long-term unemployment trends present particular concern, with individuals out of work for more than six months now comprising more than 25% of the unemployed population [3]. This structural labor market challenge suggests potential scarring effects that could persist even as headline hiring figures stabilize. The Congressional Budget Office and Federal Reserve officials have noted that benchmark revisions to labor data, expected next month, are widely anticipated to reveal that hiring was even slower than currently reported [3].

The impending conclusion of Federal Reserve Chair Jerome Powell’s term on May 15, 2026, introduces significant uncertainty into the monetary policy trajectory [3]. The Trump administration is expected to announce its nominee this month, with Kevin Warsh and Kevin Hassett emerging as front-runners. Warsh has historically adopted more hawkish policy positions, while Hassett may support more aggressive rate reductions. Governor Stephen Miran, viewed as a potential nominee, has recently advocated for “well over 100 basis points of cuts” [3]. This succession process creates execution risk for monetary policy continuity and may influence market expectations independent of economic fundamentals.

Despite cooling labor markets, inflation remains above the Federal Reserve’s 2% target, with the Congressional Budget Office projecting inflation at 2.1% by 2028 [3]. Ongoing tariff pressures and sustained consumer demand continue to provide inflationary support, while wage growth at 3.8% annually remains above productivity-adjusted norms. The Supreme Court’s pending ruling on tariff legality adds another layer of policy uncertainty, as expanded tariff authority could sustain or intensify inflationary pressures and constrain Federal Reserve easing capacity [8].

The gap between market-implied policy paths and Federal Reserve projections warrants careful monitoring. Markets are pricing approximately two rate cuts for 2026, while the central bank’s own projections and independent forecasts suggest a more measured easing trajectory [3]. This divergence could generate market volatility if economic data forces reassessment of either perspective. The CBO’s projection of 10-year Treasury yields rising to 4.3% by 2028 suggests longer-term rate pressure that may conflict with market expectations for aggressive easing [3].

The analysis reveals several risk factors warranting close monitoring. Labor market deterioration represents the most immediate concern, with the three-month moving average of payrolls now negative and long-term unemployment rising as a share of total joblessness. This trend, if sustained, could signal economic weakness beyond what current data captures, potentially triggering more aggressive Federal Reserve response than markets currently anticipate. Additionally, the upcoming Fed Chair nomination introduces policy uncertainty, as the new leadership’s approach to inflation and employment balancing may differ from the current framework. Tariff-driven inflation remains a latent risk, with further policy expansion potentially rekindling price pressures and constraining the Federal Reserve’s easing capacity. Market concentration in AI-driven growth sectors continues to support equity valuations but creates potential vulnerability if productivity gains disappoint expectations.

The current market environment presents several opportunity windows for informed participants. Mortgage-backed securities spreads have narrowed following the Trump administration’s purchase announcement, potentially offering relative value opportunities for investors with longer-term horizons. Investment-grade credit spreads have remained contained despite the evolving rate outlook, according to CreditSights and BNP Paribas analysts, suggesting continued demand for quality corporate debt [1]. The modest scale of the Fannie-Freddie purchase program relative to historical Federal Reserve QE indicates room for additional policy accommodation through this channel if labor market conditions deteriorate further.

Several near-term catalysts will influence market direction and require close attention. The January jobs report, scheduled for February 7, 2026, will prove critical for March Federal Reserve meeting expectations. CPI data release on January 15, 2026, will provide additional inflation trajectory insight. The Fed Chair nomination announcement expected this month will clarify the policy direction for the remainder of 2026. Labor data benchmark revisions in February could fundamentally alter the labor market health assessment. Finally, the Supreme Court tariff ruling remains pending and represents a significant policy uncertainty that could materially impact inflation and rate expectations.

This analysis synthesizes findings from the Bloomberg “Real Yield” broadcast dated January 9, 2026, alongside supporting data from Bloomberg, Reuters, CNBC, CNN Business, Politico, and AP News regarding the December 2025 employment report and its implications for Federal Reserve monetary policy [1][2][3][4][5][6][7][8].

The December 2025 employment report, showing 50,000 jobs added and unemployment declining to 4.4%, effectively eliminated near-term Federal Reserve rate cut expectations while maintaining the soft landing narrative that supported equity market gains. Treasury yields responded with short-dated bonds under pressure and longer-dated bonds stable, producing modest yield curve steepening. The Trump administration’s mortgage-backed securities purchase initiative introduced an alternative rate relief mechanism, though its modest scale limits immediate market impact.

The weakest annual job growth since 2003, combined with concerning labor force participation trends and elevated long-term unemployment, suggests underlying labor market challenges that could influence Federal Reserve policy as the year progresses. The upcoming Fed Chair transition, pending tariff rulings, and scheduled data releases create a dynamic environment requiring ongoing reassessment of policy and market expectations.