Podcast Summary: Thoughts on the Market

Episode: Fed’s Next Steps and Markets’ Reactions
Date: December 11, 2025
Hosts: Matthew Hornbach (Global Head of MacroStrategy, Morgan Stanley), Michael Gapen (Chief US Economist, Morgan Stanley)

Brief Overview

In this episode, Matthew Hornbach and Michael Gapen discuss the outcomes and implications of the December 2025 Federal Open Market Committee (FOMC) meeting, which resulted in another 25 basis point rate cut. They explore what the Fed’s recent actions, the evolving economic data, and policy outlook mean for markets—especially in relation to employment, inflation (notably tariffs), and expectations for both rate and yield movements into 2026.

Key Discussion Points and Insights

1. FOMC Meeting: Rate Cut and Committee Dynamics

• Divided FOMC and Shift to Data Dependency

  • The Fed cut rates by 0.25% as widely expected, but the committee was notably divided.
  • Powell communicated a transition:

    "The Fed is done with risk management rate cuts and now we're back to data dependent." — Michael Gapen, [01:00]

  • Risk management cuts refer to actions taken preemptively rather than in response to hard data. Now, future cuts will hinge on actual data trends.

• Powell’s Communication Style

  • Powell artfully balanced acknowledging the end of risk-driven cuts while not making the bar for future cuts seem insurmountably high.
  • Gapen noted the messaging was "a bit dovish" and observed Powell "fairly explicitly ruled out the risk of rate hikes." ([01:50])

2. The Labor Market: Technical Factors and Uncertainties

• Job Shedding — A Data Revision Story

  • Powell highlighted possible job losses of ~20,000/month due to “well-known technical factors.”
  • Gapen clarifies this refers to pending annual benchmark revisions from the Bureau of Labor Statistics, which might lower reported job growth by about 60,000 jobs/month for 2025 ([03:15]).
  • Despite weak job growth, unemployment remains stable, creating a "curious balance."

    "How can you have employment growth basically zero, maybe even negative, after these revisions come in and the unemployment rate relatively stable?" — Michael Gapen, [03:32]

• Labor Supply Constraints

  • Slowing immigration is further restricting labor force growth and contributes to uncertainty in labor data.

3. Inflation Outlook: Tariffs and Transitory Effects

• Tariff Pass-Through and Timeline
  • Both hosts agree inflation related to tariffs should peak in Q1 2026.
  • Firms are slow to pass on tariff costs; the inflation impulse is gradual, not immediate.
  • Year-on-year inflation could “peak at 3% or a little above” in Q1 2026, then start declining ([04:40]).
  • Gapen provides his view:

    “We think ultimately inflation from tariffs will be transitory...inflation should peak in the first quarter of the year and then start to trend down.” ([05:25])

  • Inflation is expected to remain above the Fed's 2% target through 2027, seen as the “cost of providing insurance to the labor market.”

4. Fed Policy Outlook for 2026

• Expecting More Cuts

  • The forecast: another rate cut in January 2026, then another in April, as labor market cooling continues ([06:25]).
  • By Q2 2026:

    “...the federal funds rate gets to 3% to 3.25% in the second quarter of 2026, where we think it'll stay.” — Michael Gapen

• Market Implications and Changing Leadership

  • Investors’ expectations aligned with a “hawkish cut,” but quickly turned optimistic about further easing as Powell’s data-dependent language was digested.
  • After the April 2026 meeting, a new Fed chair will take over—investors anticipate a continued dovish tilt ([08:28]).

5. Market Reactions: Yields and the Dollar

• Bond Market Moves

  • Pre-meeting, yields rose (pricing in hawkish risk), then declined sharply as dovish signals became clear ([07:30]).
  • Hornbach explains:

    “Investors were forming very similar expectations about how the FOMC statement itself would change...when that hawkish cut was delivered…investors started to consider the data that is forthcoming.” ([07:35])

• 10-year Treasury and Dollar Outlook

  • Hornbach anticipates 10-year yields will “drift modestly lower in the first half of 2026,” as the Fed eases further ([09:55]).
  • Longer-term yields are currently above policy rates—making them attractive to investors, which should keep a lid on further rate rises.

    “We don't expect a big increase in longer term interest rates...expecting interest rates in the long end to remain relatively stable with a downward bias on the dollar.” ([10:28])

  • The dollar, on a depreciation trend since January 2025, is expected to continue weakening through mid-2026 before stabilizing.

Notable Quotes & Memorable Moments

• On Fed Strategy:

  “The Fed is done with risk management rate cuts and now we're back to data dependent.”
  — Michael Gapen ([01:00])

• On Labor Market Mysteries:

  “How can you have employment growth basically zero, maybe even negative, after these revisions...and the unemployment rate relatively stable?”
  — Michael Gapen ([03:32])

• On Tariff-Driven Inflation:

  “We think ultimately inflation from tariffs will be transitory...inflation should peak in the first quarter of the year and then start to trend down.”
  — Michael Gapen ([05:25])

• On Market Psychology:

  “That is colloquially known as buying the rumor and selling the fact.”
  — Matthew Hornbach ([07:17])

• On Bond Yields vs. Policy Rate:

  “The longer term treasury yields today are...well above the Fed's policy rate and that hasn't been the case for many, many years now.”
  — Matthew Hornbach ([10:00])

Timestamps for Key Segments

• FOMC Outcome and Policy Shift: [00:08] – [02:20]
• Labor Market Technical Factors: [02:20] – [04:10]
• Inflation and Tariffs Discussion: [04:10] – [05:52]
• Fed Policy Outlook for 2026: [05:52] – [07:15]
• Market Reaction Analysis: [07:15] – [09:41]
• Yields & Dollar Forecast: [09:41] – [11:41]

Conclusion

This episode provides a detailed and nuanced analysis of the December 2025 FOMC decision, the Fed’s evolving policy framework, and what it all means for markets in 2026. The discussion is anchored in both the technical mechanics of labor market data and ongoing inflationary pressures, particularly those driven by tariffs. Listeners will gain valuable insight into how Morgan Stanley’s economists interpret the Fed’s forward guidance and its likely impact on yields, the dollar, and broader market sentiment heading into a pivotal election year and an impending leadership change at the Fed.