Federal Reserve Signals Cautious Optimism with Third Rate Cut

The U.S. Federal Reserve's third consecutive rate cut signals a dovish stance amid persistent inflation and robust economic activity. DBS Group Research notes a forecasted 'Goldilocks' economic scenario by 2026, with gradual rate cuts and strategic T-bill purchases conveying cautious confidence without immediate overheating or recession risks.

In a move interpreted as dovish amid persistent inflation and strong economic activity, the United States Federal Reserve has enacted its third consecutive 25-basis-point rate cut, adjusting the federal funds rate to 3.75%. Analysts from DBS Group Research provide three main insights from this decision.

According to the Summary of Economic Projections (SEP), the economy is set to hit a 'Goldilocks' phase by 2026, characterized by balanced growth and low inflation. GDP growth projections have been revised upwards to 2.3%, from 1.8%, while core PCE inflation has been marginally trimmed to 2.5% from 2.6%. Eugene Leow, Senior Rates Strategist at DBS Bank, notes that the dot-plot remains unchanged, indicating one rate cut each in 2026 and 2027. Moreover, the Federal Reserve will commence the purchase of USD 40 billion per month in T-bills starting December 12, as a strategy to assure that reserve levels do not fall excessively.

This steady purchase of T-bills is projected to continue for several months before tapering off, and it should not be conflated with quantitative easing. DBS analysts interpret these moves as a measure of confidence in the economy's path forward through 2026 without severe overheating or recession. Unlike past economic cycles where rate cuts suggested economic distress, the current trend suggests a strategic normalization approach.

DBS Chief Economist Taimur Baig remarked that the central bank is poised to continue its easing policy, despite potential political implications and pressures from the White House, as the 2026 election cycle picks up pace. He cautions, however, that the Federal Reserve's capacity to further reduce rates will be increasingly constrained by structural elements like tariffs, restricted immigration, AI-driven energy demands, and tax reductions, which keep inflation persistently high.

The report asserts that the labor market shows no imminent signs of collapse, nor does economic growth appear to be stalling. Key growth indicators, from retail sales to investments, reflect ongoing GDP expansion, with sustained demand. Yet, with factors like tariffs and AI-related energy demands applying upward pressure on inflation, the opportunity for continued rate cuts is expected to be significantly limited.

(With inputs from agencies.)