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The End of the Cutting Cycle?

It is not just the bond market that is having doubts about the stance of monetary policy. Federal Reserve officials are also seeing the light.

After lopping off a full percentage point from rates since September, at least some officials at the Fed appear to be questioning whether further easing is warranted. Judging by recent remarks and the latest minutes from their December Federal Open Market Committee (FOMC) meeting, the answer appears to be migrating toward a firm no.

Minutes from the December meeting, released Wednesday, reveal that at least some Fed officials are increasingly worried about inflation risks. “Almost all” officials noted that upside risks to inflation had grown—an acknowledgment that the Fed may have overdone it with rate cuts in an economy still posting respectable growth. Yet despite this newfound caution, the minutes show no appetite for reversing course toward rate hikes. Instead, the message was one of careful watchfulness and, perhaps, quiet regret.

The December cut, the third in a row, brought the Fed’s target range down to 4.25 percent to 4.5 percent. Cleveland Fed President Beth Hammack dissented and said she wanted to see inflation move closer to the Fed’s two percent target before supporting further cuts. Other officials were more diplomatic, hinting that while further easing could still be on the table, the conditions for such action—a clear economic slowdown or falling inflation—were conspicuously absent.

Enter Kansas City Fed President Jeff Schmid, who will become a voting member of the FOMC this month. Schmid, speaking Thursday, suggested that “interest rates might be very close to their longer-run level now” and endorsed a gradual, data-driven approach. That doesn’t mean no more cuts in the months ahead. It means that in Schmid’s view there should be no more cuts at all unless the economy weakens enough to need monetary stimulus. Neutral is now.

That’s a far cry from Fed Chairman Jerome Powell and Governor Chris Waller’s view that rates are currently restrictive and have further to go before hitting the neutral level.

The Market’s Reaction: Yields Are Rising

Here’s the awkward part for the Fed: The bond market doesn’t seem to be buying the official story that rates are restrictive and will still decline. Typically, rate cuts lead to lower yields on longer-term bonds. Instead, since the Fed’s 50 basis point cut in mid-September, yields have done the opposite—rising sharply. The 10-year Treasury yield, which stood at 3.60 percent before the cut, has since surged to 4.70 percent.

Why? As Jim Bianco aptly puts it, the market might not like rate cuts when they seem gratuitous. With GDP growth hovering around 2.5 percent—hardly recessionary territory—and fiscal stimulus looming from the incoming Trump administration, cutting rates risks stoking inflation expectations rather than alleviating economic stress. The Fed’s effort to be proactive may have backfired, fueling concerns that monetary policy is too loose for an economy still running near potential.

Bianco’s explanation makes more sense than some of the alternative theories that he was good enough to take notice of. Former Chicago Fed President Charlie Evans, for instance, pointed to deficits, tariffs, and even AI as possible culprits for rising yields—an answer that reads more like a grab bag of economic buzzwords than a coherent theory. Paul Krugman offered his own twist, suggesting that yields might reflect an “insanity premium” tied to fears of Trump’s policy proposals. But as Bianco rightly notes, many these factors were present before September, when yields were considerably lower. The most significant change has been the Fed’s sudden enthusiasm for rate cuts.

Time to Hold the Line

If the Fed’s goal was to calm markets or provide comfort that the Fed has its eye on the economic ball, the rising yield curve suggests it missed the mark. Schmid’s remarks, along with those of Governor Michelle Bowman, hint at a policy pivot: the easing cycle is likely over. Bowman, in a speech Thursday, expressed concern that current policy “may not be as restrictive as others may see it,” not quite going as far as Schmid but definitely out of sync with the Powell-Waller view.

With Schmid joining the voting ranks and Bowman’s voice carrying weight as a permanent voter, the January FOMC meeting may bring a clearer signal: no more cuts unless inflation cools or growth falters significantly. This isn’t exactly hawkish, but it’s a far cry from the dovish tone that dominated Fed communications in late 2024. In other words, the Fed might finally be ready to hit pause.

A more explicit commitment to holding rates steady would help reduce uncertainty in bond markets. The current ambiguity—a Fed still nominally open to further cuts despite mounting inflation concerns—has done little to anchor expectations. While a pause may not thrill everyone, it would at least offer a sign that the Fed has not once again fallen behind the economic curve.