Key Highlights

• No change in interest rates expected this week
• January FOMC seen as uneventful amid Powell succession focus
• Fed expected to dominate T-bill demand as funding details emerge

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January FOMC unlikely to change much

EXHIBIT #1: A FEW MORE CUTS EXPECTED THROUGH THE END OF 2027

_{Source: BNY Markets, Bloomberg}

EXHIBIT #2: ODDS FOR NEXT FOMC SHIFTING

_{Source: BNY Markets, Polymarket, Bloomberg}

No change in the policy rate is expected at Wednesday’s FOMC meeting. Market expectations imply a slight 3.4% chance of a cut. Indeed, the next rate move is not expected until at least July, and the year-end federal funds rate is seen to be just 45bp lower than the current 3.75% target (3.64% effective). Fedspeakers who shared their views before the communications blackout went into effect generally poured cold water on the idea of an imminent policy move, and the macro data have held up quite well in recent weeks.

The market’s modest expectations through the end of 2026 extend into 2027. As Exhibit #1 shows, the implied rate for December 2027 is nearly identical to that for this December. Essentially, the market expects only slight policy easing this year, followed by a steady stance next year. In fact, the implied year-end rates for 2026 and 2027 have edged higher, suggesting that the market believes the Fed is nearly done adjusting policy and will stay at that setting for a while.

This meeting is therefore expected to be uneventful from a monetary policy standpoint. There is no Summary of Economic Projections in January. Only the policy statement will be released, followed by the regular post-meeting press conference with Chair Powell. The statement may offer insight into how the Fed sees the balance of risks – upward for inflation, downward for the labor market – but we don’t expect it to differ meaningfully from December’s FOMC. That statement, largely unchanged from October, cited downside risks to the labor market but did not address inflation pressures. Given the recent stickiness in November’s PCE report, any new language on inflation would likely be viewed as marginally hawkish.

The central bank didn’t only move the policy rate in late 2025. The Fed ended quantitative tightening in October and began reserve management purchases (RMPs) in December. The latter were intended to shore up funding markets once system-wide bank reserves moved from abundant to merely ample (see here). RMPs in December and January have amounted to $40bn per month. We don’t expect this policy to change, as repo market volatility has remained subdued in recent weeks.

Looming over the proceedings will be questions about Fed independence, especially following the Supreme Court hearing on Governor Lisa Cook’s bid to remain on the Board and the Department of Justice investigation into the Fed. We don’t expect Powell to comment in any detail and anticipate he will remain silent, as he has been, if asked at the press conference.

The market is also increasingly focused on an eventual, if not imminent, announcement of Powell’s successor. In Exhibit #2, we plot the evolution of market expectations for three of the presumed frontrunners. The National Economic Council Director Kevin Hassett is no longer the odds-on favorite, as he was in late 2025. Former Fed Governor Kevin Warsh and Rick Rieder, the current BlackRock CIO for fixed income, now hold higher odds, according to prediction markets. Based on recent observations, odds for Hassett (~7%), Warsh (~28%), Rieder (~47%) and Governor Chris Waller (not shown, with 9%) add up to just under 100%. Assuming these nascent markets are efficient, they imply a 9% chance that someone outside this list could be named. While the succession discussion is clearly on the market’s mind, we don’t expect it to be addressed at the FOMC.

Quarterly refunding, T-bill supply and Fed purchases

EXHIBIT #3: T-BILLS VS. COUPONS LIKELY TO STAY JUST NORTH OF 20%

_{Source: BNY Markets, U.S. Treasury}

EXHIBIT #4: SWAP SPREADS STAY ELEVATED

_{Source: BNY Markets, Bloomberg}

Turning from the central bank to the U.S. Treasury, next week features the release of the government’s quarterly borrowing estimates. Net borrowing of around $550bn is expected to be announced, not far off the previously anticipated $578bn for the January–March quarter. Coupon sizes have not been increased in recent quarterly refunding announcements, and we don’t expect that to change this time around. This suggests that the proportion of T-bill issuance will stay well above 20% (Exhibit #3).

Between RMPs and the Fed’s policy of reinvesting agency proceeds into front-end paper, we anticipate that the Fed will buy close to $400bn in bills this year. That assumes $40bn per month in RMPs through April and $20bn per month thereafter, with an additional $10bn to $15bn per month in balance sheet reinvestments. Assuming total government issuance in 2026 is around $1.75tn, and about 25% of that is in T-bills (approximately $450bn), the Fed would be the main buyer next year.

That doesn’t mean fiscal concerns are entirely off the table. As shown in Exhibit #4, the 10y10y swap rate – a market-based measure of future yield expectations – is now near 4.7%, its highest level since the pandemic. It’s rare for this yield to exceed current 10y spot yields by such a margin, and we view it as a sign that fiscal concerns persist.

Rates outlook

As noted, we expect no rate move at the January FOMC this week. However, we maintain a more dovish view than the market for later in 2026. We continue to expect three cuts, likely in the second half of the year. This contrasts with market expectations of just under two cuts and the Fed’s most recent dot plot showing only one.

Our outlook is predicated on concerns that the labor market – currently moribund – will weaken further by midyear. We note that employment growth in cyclically exposed industries has been negative in five of the last six months. The January Beige Book indicates flat employment growth and a lack of new job creation. This negligible employment growth can be explained by supply-side factors. A declining supply of non-native workers and still weak, post-COVID participation from the broader population can flatter the unemployment rate despite mediocre job growth. However, the labor market is susceptible to downward shocks at its current pace of job creation.

Inflation remains sticky, and its recent behavior doesn’t suggest it is easing. This may help explain the market’s relatively modest expectations this year and next. Nonetheless, we believe the Fed, when faced with modestly above-target inflation and a weakening job market, will prioritize the employment side of its mandate.

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