The Federal Reserve's January rate cut just became a lot less likely.

Bond traders all but eliminated their bets that the central bank would lower interest rates later this month after Friday's December jobs report showed the unemployment rate falling more than expected to 4.4%.

The resulting selloff in short-maturity Treasuries lifted the two-year note's yield to 4.35%, the highest level of the year. Futures markets now price in almost no chance of a rate cut at the Fed's January 28-29 meeting.

What the Jobs Report Showed

The December employment report presented a mixed but ultimately solid picture of the U.S. labor market:

  • Nonfarm Payrolls: +50,000 jobs, below the 73,000 economists had expected
  • Unemployment Rate: 4.4%, down from 4.5% and better than the 4.5% forecast
  • Average Hourly Earnings: Rose 0.3% month-over-month, in line with expectations

While the headline payrolls number disappointed, the declining unemployment rate signals a labor market that remains relatively tight. For the Fed, this removes any urgency to ease policy further in the near term.

The Fed's Balancing Act

Federal Reserve officials have been navigating a delicate balance in recent months. Inflation has fallen substantially from its 2022-2023 peaks, but it remains above the Fed's 2% target. Meanwhile, the labor market has cooled from its overheated state but continues to show resilience.

The three rate cuts delivered in the second half of 2025—totaling 75 basis points—brought the federal funds rate to its current range of 3.50% to 3.75%. That's a meaningful reduction from the cycle peak, but rates remain well above the near-zero levels of the pandemic era.

Internal Divisions at the Fed

Complicating the outlook is significant disagreement among Fed officials about the appropriate path for policy.

Fed Governor Stephen Miran has argued aggressively for more cuts, pushing for reductions totaling more than 100 basis points (1 percentage point) in 2026. In recent remarks, Miran said inflation is already running close to the Fed's 2% target once temporary measurement distortions are stripped out, and that current policy remains "clearly restrictive."

"Rate reductions totaling more than 100 basis points are justified as underlying inflation pressures continue to fade."— Fed Governor Stephen Miran

Other officials, including Minneapolis Fed President Neel Kashkari, have taken a more cautious stance, suggesting the Fed should hold rates steady until there's clearer evidence that inflation is sustainably returning to target.

What Bond Markets Are Pricing

Despite Friday's selloff, bond traders maintained an outlook for two rate cuts overall in 2026. However, the expected timing has shifted:

  • January Meeting: Near-zero probability of a cut
  • March Meeting: Low probability, approximately 15-20%
  • First Cut Expected: Mid-year (May or June)
  • Total 2026 Cuts: Two 25-basis-point reductions

This represents a significant repricing from just a month ago, when markets were pricing in three or four cuts for the year.

The Leadership Transition

Adding another layer of uncertainty: Fed Chair Jerome Powell's term expires in May. President Trump is expected to announce his nominee for the role in coming weeks, and the choice could significantly influence the Fed's policy direction.

Before his term ends, Powell will preside over three more meetings of the Federal Open Market Committee (FOMC). The transition period could create additional volatility in rate expectations as markets assess the likely policy stance of the next chair.

FOMC Voting Changes

The composition of the FOMC voting members also shifts in 2026. The presidents of the Federal Reserve Banks in Cleveland, Philadelphia, Dallas, and Minneapolis gain votes, replacing the presidents from Boston, Chicago, Kansas City, and St. Louis.

These rotations can subtly influence policy, though the chair and Fed Board of Governors maintain the dominant voice in rate decisions.

What It Means for Investors

The recalibration of rate expectations has several implications for markets:

Bond Investors

Short-duration bonds have sold off as rate cut expectations faded, pushing yields higher. For investors in money market funds or short-term Treasuries, this means attractive yields may persist longer than previously anticipated.

Long-term bond investors face a more complex picture. If the economy remains resilient and inflation sticky, long-duration bonds could face continued pressure. However, any economic weakness could quickly reverse this dynamic.

Stock Investors

Equities have historically shown mixed reactions to rate expectations. Lower expected rates generally support higher stock valuations, while higher-for-longer rates can pressure multiples.

That said, Friday's stock market rally—with the S&P 500 hitting a record high—suggests investors are comfortable with the current rate outlook as long as the economy remains solid.

Homebuyers and Borrowers

For those hoping for lower mortgage rates, the fading of near-term rate cut expectations is disappointing news. Mortgage rates, which track long-term Treasury yields more than short-term rates, are likely to remain elevated in the near term.

The CBO's Economic Projections

The Congressional Budget Office recently updated its economic projections, expecting the unemployment rate to peak at 4.6% in 2026 before easing to 4.4% by 2028. Real GDP growth is forecast at 2.2% for 2026, supported by recent tax and spending legislation.

These projections align with a "soft landing" scenario where the economy slows enough to control inflation without tipping into recession—the outcome the Fed has been trying to engineer.

The Bottom Line

Friday's jobs report reinforced the view that the Fed will proceed cautiously with additional rate cuts in 2026. While the easing cycle isn't over, it's likely to unfold more slowly than markets had been pricing just weeks ago.

For investors, this means adjusting expectations rather than strategies. The fundamental picture—a resilient economy with gradually moderating inflation—remains supportive for risk assets, even if the pace of rate cuts disappoints.

Interest rate expectations can shift rapidly based on economic data and Fed communications. Investors should maintain diversified portfolios appropriate for their goals and risk tolerance.