It’s the time of year when markets get a little festive, and investors start whispering about that magical Santa Rally. But as we sit here on the eve of the Federal Reserve’s final meeting of 2025, the mood feels more like a tense family dinner than a holiday celebration. With rate cuts already priced in, geopolitical tensions simmering, and a new administration ready to shake things up, the question isn’t whether the Fed will deliver—it’s what happens next, and whether the markets are ready for it.
The Fed’s Big Moment: What Markets Are Really Betting On
Right now, the bond market is pricing in nearly a 95% chance that the Fed will cut rates by another quarter point. That’s the third cut in a row, bringing the federal funds rate down to around 3.5% to 3.75%. On the surface, it looks like a smooth landing. But dig a little deeper, and you realize the real story is in the details—the dot plot, the economic projections, and, of course, what Chair Powell says in his press conference.
I’ve been watching these meetings for years, and this one feels different. Powell is in his final stretch as chair, and his words carry less weight heading into the new year than they once did. Markets seem to be shrugging off the current Fed and already looking ahead to what comes next. In my experience, when the focus shifts that far forward, it often means investors are bracing for change—sometimes the kind that doesn’t come gently.
A Lame Duck Chair and the Shadow of What’s Coming
Powell has done a remarkable job navigating the post-pandemic economy, but his term ends in May 2026. Whoever replaces him—whether it’s someone like Kevin Warsh or another name floating around—will inherit a very different landscape. The market is already pricing in a more dovish Fed next year, one that might be willing to go further on cuts to support growth. But is that realistic? Or are we setting ourselves up for disappointment?
One thing that’s often overlooked is the level of coordination we’ll see between the Treasury, the Fed, and the administration. With Scott Bessent at Treasury, there’s a real chance for some creative thinking—tools like yield curve control, operation twist, or even a more aggressive approach to quantitative easing. The goal seems to be hitting that 3-3-3 target: 3% growth, 3% front-end yields, and 10-year yields in the 3% handle. Ambitious? Absolutely. But in a world where traditional tools are running out of steam, out-of-the-box ideas might be the only way forward.
The market is still underpricing the coordination we’ll see between the Treasury, the Fed, and the administration.
That’s the part that keeps me up at night. If the new team decides to go all-in on supporting the economy, we could see bond yields drop faster than expected. But if inflation surprises to the upside or growth proves more resilient, the opposite could happen—and quickly.
My Bond Market Outlook for 2026
Let’s get specific. I expect the Fed funds rate to be at 3% or below by the June 2026 meeting at the latest. That would mean a few more cuts next year, but probably not the aggressive easing some are hoping for. The yield curve will steepen—2s versus 10s are currently around 57 basis points, but I think we’ll see that widen out without the 10-year ever really staying above 4%. A range of 3.6% to 3.8% feels reasonable for the long end.
- Short-term rates continue to fall as the Fed eases
- Longer-term yields stay anchored by policy coordination
- Any spikes in yields will be met with quick intervention
Of course, there will be bumps along the way. Periods where longer bond yields push higher are inevitable, especially if inflation data surprises or if global events flare up. But I expect decisive action to cap those moves. The bond market vigilantes might grumble, but they won’t win this time.
Geopolitical Risks: Ukraine, Russia, and Venezuela
While the Fed dominates headlines, the bigger risks might be coming from abroad. The Ukraine-Russia conflict remains a wildcard. Peace talks are ongoing, but the versions of “peace” that Ukraine and Russia are willing to accept don’t look much alike. Either one side gains significant ground (likely Russia), or Europe steps up with aggressive sanctions or even seizing frozen reserves. The latter would be a game-changer, but it’s hard to see the political will for it.
Then there’s Venezuela. The U.S. military presence in the region is hard to ignore, and the focus on oil seems clear. With the USS Ford carrier group in the area and talk of regime change, the administration is clearly eyeing Venezuela’s vast reserves. It’s a statement to adversaries, a push against drug cartels, and a bid for energy security. But China and Russia won’t sit idly by. How they respond could ripple through global markets.
China has been quiet on Ukraine, but they’re deeply involved in Venezuela’s oil sector. Any major shift there would require Beijing’s acquiescence—and that’s far from guaranteed.
The Santa Rally: Real or Just Holiday Cheer?
Ah, the Santa Rally. Everyone loves talking about it this time of year. Historically, the last week of December and the first few days of January tend to be strong. But in 2025, with valuations stretched, AI spending questions, and electricity bottlenecks looming, I’m not holding my breath for a blowout rally. Seasonality is real, and easing financial conditions help, but fear tends to creep back in later—probably early next year.
- Valuations and AI spending remain key concerns
- Supply chain risks and trade uncertainties linger
- Japanese yields and the carry trade could add volatility
- The consumer’s health is still debated—K-shaped or otherwise
That said, I don’t think we’re heading for a major correction just yet. The market has a way of surprising when everyone is looking the other way.
Bottom Line: Stay Nimble
The list of risks hasn’t gone away, but neither has the underlying resilience. The Fed meeting this week will set the tone, but the real action will come in 2026 as new leadership takes shape and global tensions play out. In the meantime, keep an eye on the bond market—it’s often the best indicator of what’s coming next.
Whatever happens, one thing is clear: markets hate uncertainty, but they love surprises. And 2026 is shaping up to have plenty of both.
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