Written by: Zhu Yu, Jin Shi Data

This week's Federal Reserve policy meeting is expected to be the most controversial in many years, more like a stress test for the financial markets to observe the direction of the debate on U.S. monetary policy in 2026.

As the meeting approaches, the market is almost certain that the Federal Reserve will cut interest rates, despite the Federal Open Market Committee (FOMC) being in a period of the most significant internal disagreement in years.

During the record 43-day U.S. government shutdown, there was almost no data available for analysis, and the signals released by Federal Reserve officials were contradictory. Coupled with the Trump administration's continuous pressure for rate cuts, the weeks leading up to the meeting have put investors under significant stress.

In the past three weeks, the market's expectation that the Federal Reserve will lower the benchmark overnight rate by 25 basis points to a range of 3.50%-3.75% has risen from 30% to 87%, primarily driven by New York Fed President Williams' recent support for "insurance rate cuts."

Investment banks such as Morgan Stanley, JPMorgan, and Bank of America have responded by revising their forecasts, believing that the meeting on December 9-10 will result in a rate cut.

However, analysts expect that up to 5 of the 12 voting members of the FOMC will hold differing opinions, which further reinforces the narrative in the market that the Federal Reserve is becoming increasingly politicized.

Since 2019, the policy committee has never had three or more dissenting votes in a single meeting, a situation that has only occurred nine times since 1990. Analysts currently expect this divergence to continue.

Sally Greig, global bond head at Baillie Gifford, a Scottish long-term investment management company, stated: "The more disagreements you see, and the more public those disagreements are, the more it raises questions about how willing the Federal Reserve is to become more politicized. This raises the question: to what extent is the Federal Reserve inclined to 'err on the side of dovishness' for its own peace of mind? How deep is their fear of losing their jobs?"

The members of the Federal Reserve Board nominated by Trump have generally leaned dovish. His economic advisor Kevin Hassett is a popular candidate to replace Fed Chair Powell next year and has called for lower interest rates. Another of Trump's economic advisors, Stephen Miran, who just filled a vacancy on the board in September, has been pushing for more significant rate cuts.

However, other FOMC members, including Kansas City Fed President George, St. Louis Fed President Bullard, and Fed Vice Chair Jefferson, have also openly expressed a preference for keeping rates unchanged.

Williams is typically seen as a more neutral official, but in the weeks following Powell's statement in October that a December rate cut was "far from a done deal," Williams has clearly shown a dovish stance regarding a December rate cut, causing more investors to feel uneasy about political pressures.

Focus on Powell's Successor

Analysts Steve Englander and John Davies from Standard Chartered Bank wrote this week that even if the Federal Reserve cuts rates this week and signals a hold in January, "given the 180-degree turn in its stance from the 'hawkish' signals released in the October meeting and minutes, the market may not trust this indication."

Traders noted that the rise in volatility reflected in short-term interest rate options pricing, as well as the steepening of the long-term yield curve, are signs of this concern.

A bond trader in London stated: "The market is now more sensitive; people have to decide whose words to trust."

However, interest rate futures market data shows that the market currently expects the Federal Reserve to cut rates by only about 75 basis points by the end of next year.

Fabio Bassi, head of cross-asset strategy at JPMorgan, stated that investors should not focus solely on the December meeting, "the Federal Reserve under Powell is not inclined to take very aggressive actions; they are implementing 'insurance' rate cuts."

However, Trump seems determined to lower borrowing costs before the U.S. midterm elections at the end of next year. In an interview released by Politico on Tuesday, the Republican president, who has repeatedly expressed dissatisfaction with Powell's leadership of the Federal Reserve, stated that supporting an immediate rate cut would be a necessary condition for him to choose the central bank's leader.

The Federal Reserve has announced rate cuts in its September and October meetings.

Trump's attempt to dismiss Federal Reserve Governor Lisa Cook, who was appointed by former President Joe Biden, along with Treasury Secretary Yellen's recent comments about potentially changing the appointment process for regional Fed presidents, has intensified concerns about the politicization of the Federal Reserve.

But to what extent this political pressure will affect the Federal Reserve remains unclear.

James Athey, fixed income fund manager at London-based Marlborough Investment Group, stated: "I understand why people are discussing this, but given the current known circumstances, I think it is unreasonable to factor this into market pricing right now. I see it as a risk rather than a foregone conclusion."

Tim Winstone, head of investment-grade credit at Janus Henderson Investors, noted that some clients are re-evaluating their options when allocating incremental funds, and have reduced their investments in the U.S., "This indicates that people are realizing that the credibility historically represented by the U.S. is facing higher risks. The evolving political landscape and its impact on the Federal Reserve are undoubtedly among the factors being considered."

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