With Fed set to meet next week, December's rate cut now looks questionable

Six months ago, Federal Reserve officials were deeply divided over whether to cut interest rates for a third consecutive meeting. The rate cutters won the day, but the data since then has pointed toward that having been a mistake.

Why it matters: With the first policy decision of the Kevin Warsh Fed on tap next week, an uncomfortable backdrop is the mounting evidence that the central bank overshot in its easing campaign last year.

• Job growth has surged since then, and inflation has exceeded projections — even when the energy shock from the Iran war is excluded.

Flashback: The November-December time frame featured one of the more curious episodes in modern Fed history, as an increasingly vocal contingent of officials, mostly presidents of reserve banks around the country, pushed back against plans to continue lowering rates.

• For a while, it looked as if the December rate-cut vote would feature the most dissents in decades. But then-chair Jerome Powell corralled a consensus for a rate reduction, with only two hawkish dissents (the Kansas City Fed's Jeff Schmid and Chicago Fed's Austan Goolsbee).
• With inflation elevated and the job market looking vulnerable, the majority of the policy committee anticipated that the latter was the more urgent concern, and that inflation would return to the Fed's 2% target once the one-time effects of tariffs passed through.

Reality check: Securing that rate cut may have been a Pyrrhic victory for the doves. Low rates might be adding fuel to the inflationary fire, and markets are now pricing meaningful odds that the central bank will have to reverse course and raise rates this year.

By the numbers: Core Personal Consumption Expenditures inflation — excluding food and energy — was tracking at 2.8% year over year in the most recent data available at the time of the December rate-cut decision. At that time, the median Fed official expected it would fall to 2.5% in 2026.

• But through the first four months of this year, core PCE inflation has reaccelerated to a 4.1% annual rate.
• Overall PCE inflation, boosted by the energy price surge from the Iran war, is clocking an even faster 5.5% annual rate through the first four months of 2026.

State of play: The labor market, meanwhile, has proven more resilient than one would expect, given all the fretting late last year.

• The unemployment rate has been stable at 4.3% for the last three months, and job creation has reaccelerated, averaging 114,000 per month added so far this year after flatlining in 2025 (an average of 10,000 jobs per month).
• There was a lot of worry in 2025 that the weak job growth reflected soft demand for workers in addition to lower labor supply, thanks to demographic change and immigration policy.
• Regardless of how much the slump and now resurgence in job growth reflect labor supply versus demand, it's hard to look at the outcomes and see a labor market in urgent need of monetary stimulus.

Between the lines: It's not necessarily the case that excessive rate-cutting is the cause of the overshooting on inflation and the labor market. The impact of interest rate policy is too lagged and uncertain to say that with confidence.

• But the result is a strong possibility that the monetary policy dials are now improperly tuned for where the economy actually stands in mid-2026 — offering extra stimulus when conditions would call for monetary policy to be more neutral, or even pumping the brakes on economic activity.

What they're saying: "Fortunately, the labor market seems to have stabilized in recent months," governor Christopher Waller said last month, adding that "unless it dramatically deteriorates, I do not expect it to be a major factor driving my view of the appropriate stance of monetary policy in the near term."

• "Inflation, on the other hand, will be the driving force," he said, advocating for leaving rates steady for now but stating he "would not hesitate" to raise rates if inflation expectations were to become unanchored.
• Contrast that with Waller's words six months ago: "A December cut," he said, "will provide additional insurance against an acceleration in the weakening of the labor market."

The bottom line: As Warsh charts the course forward for policy, he must grapple with the possibility that the rates policy he inherits is ill-suited for the economic moment.