Divisions within the Federal Reserve are becoming increasingly apparent, with consensus on direction but stark differences in timing.
According to trading desk analysis, Morgan Stanley's Michael T. Gapen team released a report on December 22, analyzing statements from five Fed officials through December 19. The core conclusion is clear: The federal funds rate will inevitably decline, but fierce debate persists over "when" and "by how much."
For investors, the trading logic has shifted from "whether rates will be cut" to betting on which arguments will dominate policy decisions. The current landscape shows clear polarization: Hawks like Bostic and Goolsbee advocate patience, citing sticky inflation and tariff impacts, while doves such as Miran and Waller push for "front-loaded cuts," warning of labor market weakness.
A critical signal for markets will be the upcoming December jobs report. If unemployment continues rising—validating Waller’s view that job growth is "effectively near zero"—markets will likely reprice rate cuts for January and April next year. Conversely, strong data could delay cuts until late 2026.
Additionally, the Fed has begun purchasing short-term Treasuries to manage reserves. While officials deny this constitutes quantitative easing (QE), the move represents a liquidity management tweak that warrants close investor scrutiny.
**Hawks vs. Doves: Aggressive Cuts vs. Data Dependence** Fed divisions have never been more public. Morgan Stanley’s analysis categorizes two camps:
- **Front-loaded cut advocates (Miran, Waller, Williams)**: Governor Miran, the most aggressive, voted for a 50-basis-point cut in September, arguing policy is overly restrictive. He warns delayed action risks sub-2% inflation by 2027 and excessive labor market slack. Waller explicitly ties further cuts to controlled inflation and stable expectations, while Williams stresses a "data-dependent" approach, making him the most cautious dove.
- **Wait-and-see proponents (Bostic, Goolsbee)**: Atlanta’s Bostic and Chicago’s Goolsbee prioritize inflation persistence, urging proof that tariff-driven pressures are transitory before cutting.
**Growth Outlook: Betting on a 2026 Rebound** Despite 2025’s policy uncertainty and government shutdown risks, officials broadly expect 2026 growth acceleration. Williams cites fiscal support, easing financial conditions, and AI investment lifting real GDP to ~2.25%, up from 2025’s ~1.5%. Waller agrees, noting limited downside risks once tariff uncertainty fades.
**Labor Market Alarm: "Near-Zero" Job Growth?** The report’s most troubling data point: Waller warns the labor market is unhealthy, with monthly job adds of 50,000–60,000—effectively zero after revisions. Miran adds that prolonged weakness shows no signs of reversing, demanding preemptive easing to sustain employment.
**Inflation Puzzle: Tariffs and "Phantom Inflation"** Technical splits persist on whether tariff-driven inflation is transitory: - Williams attributes stalled disinflation (now ~2.75%) largely to tariffs (~0.5-ppt impact), but sees muted pass-through effects. - Miran argues exporters absorb ~70% of tariff costs, making consumer-price impacts negligible ("0.2% noise"). He dismisses housing inflation as "lagged echoes" of past imbalances. - Hawks like Bostic fear spiraling inflation, while Goolsbee resists cuts until tariff effects are confirmed temporary.
**QE Denial: Just Reserve Management?** The Fed’s Treasury bill purchases sparked QE speculation, but Waller and Williams reject this. They frame it as "organic balance-sheet growth" (~$20–25B monthly) to meet cash and reserve needs, stressing short-term purchases target liquidity—not long-term yield suppression like QE.
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