A House Divided Against Itself: The Fed's December Reckoning

Wednesday's Federal Reserve meeting will be remembered not for the rate cut it delivered, but for the institutional strain it exposed. A 9-3 vote is rare enough to mark a turning point. Rare enough to suggest we're watching something that doesn't happen often—and when it does, it usually signals deeper disagreement about which way the ship is headed.

The Fed cut 25 basis points, as expected. The funds rate now sits at 3.5%-3.75%. Powell sounded measured. Stocks rallied. The theater played out correctly. But underneath, three officials—Stephen Miran, Austan Goolsbee, and Jeffrey Schmid—either wanted more cutting or no cutting at all. That divergence matters more than the cut itself.

The Disagreement That Matters

Here's what's historically significant: This is the first time since 2019 that the FOMC split this visibly. For those who lived through the post-2008 consensus-building era, when the Fed spoke with one unified voice as a form of monetary policy theater, this fracture is striking. It suggests the committee has moved from a world of shared assumptions to one where fundamental disagreement exists about the economy's trajectory.

Miran wanted a 50-basis-point cut, signaling he reads the labor market deterioration as the dominant concern. Goolsbee and Schmid wanted no cut at all, fearing inflation hasn't actually cooled as much as the headline numbers suggest. Both positions have intellectual merit. Neither is obviously wrong. That's the problem.

The dot plot didn't help clarify things. The Fed is projecting only one rate cut for all of 2026. Yet traders are pricing in a 68% probability of two or more cuts next year. The market and the Fed don't trust each other's reading of the future. That's unusual, and it creates a particular kind of instability—not a violent crash, but a grinding uncertainty that makes risk management harder for anyone trying to position a portfolio.

The Complicating Factor: Personnel

Powell said this was "a close call." That language matters more than people realize. A "close call" at a central bank isn't poetic flourish—it's signaling that the committee is genuinely divided and that reasonable people disagree. When the Fed head has to say that, you're watching an institution negotiate between competing visions of economic reality.

The next complication arrives in weeks. Trump has signaled he'll name a new Fed chair soon, with Kevin Hassett the betting favorite at 72% odds, according to prediction markets. Hassett has publicly advocated for a 50-basis-point cut, making him a dovish voice outside the Fed that may soon be inside it. The CNBC Fed Survey shows 84% of respondents believe Trump will pick Hassett, but only 11% think he should. Traders are hedging against a regime where the Fed chair is selected for his willingness to cut rates aggressively—a departure from the independence doctrine that has governed the Fed since Volcker.

This uncertainty alone could explain some of why the market is repricing 2026's rate path. If there's a chance the Fed gets a new chair who cuts faster than Powell would, markets rationally demand insurance against that possibility.

What the Data Actually Says

This is where it gets murky. The labor market is cooling—we've seen announced job cuts cross 1.1 million for 2025, driven by AI, restructuring, and tariff concerns. That's real. The unemployment story supports cutting rates to cushion a potential slide.

But inflation? September PCE data came in delayed due to the government shutdown that ran 42 days through November 12. Core PCE at 2.8% is still above the 2% target. Whether it's genuinely sticky or just reflecting transitory factors isn't clear from the data we have. The Fed has been operating with incomplete information, making policy while flying partially blind.

Worse, Treasury yields have actually moved higher even as the Fed cuts. The 10-year touched 4.2% in recent weeks despite expectations for three consecutive rate reductions. That's a divergence that typically suggests the market sees inflation staying elevated, or that investors are demanding higher yields to hold longer-dated debt in an uncertain environment. Either way, it suggests the Fed's cutting is happening against structural headwinds it may not fully control.

The Real Problem: No Consensus on the Baseline

Every significant financial crisis or policy error in modern history has involved a central bank operating on a false baseline—a shared view of economic reality that turned out to be wrong. In 2007, the baseline was "housing prices always rise." In the 1970s, it was "inflation and unemployment can't both rise." In 2020, it was "this will be V-shaped."

Right now, the Fed has no shared baseline. Some officials believe the labor market is the binding constraint on growth and that cutting aggressively prevents a hard landing. Others believe inflation is still a residual threat and that cutting into this environment risks reigniting it. Those two views cannot both be true. One will be vindicated; the other will look foolish in hindsight.

The problem is that the Fed has to operate now, without the luxury of hindsight. So it compromises—it cuts, but signals that this might be it for a while. It buys Treasury bills ($40 billion to start, running elevated for months) to manage what Powell calls being "well positioned to wait and see." Translation: We're not sure, so we're keeping options open.

That's not unreasonable. But it's also not reassuring. Markets prefer clarity to prudent ambiguity.

What Comes Next

Powell didn't commit to any cuts in January. The dot plot suggests patience through 2026. But the market has already priced in two or three cuts next year. Someone's wrong, and the gap between those expectations will narrow violently when the data comes in and forces a reckoning.

The Oracle earnings miss—revenue came in short despite exploding AI demand—hints that maybe the capex cycle doesn't translate to earnings as easily as bulls assumed. That's not a death knell for the cycle. But it's a warning that at some point, massive spending on AI has to produce returns, or the whole capital allocation story gets questioned.

Between a divided Fed, uncertain data, a potential leadership transition, and the first signs that the capex-to-earnings story might be more complicated than expected, the market is entering a phase where conviction matters less than flexibility. The Santa Claus rally might still come, as some strategists suggest. But it'll be built on quicksand—a hope that the Fed's patient approach and lower rates can juice equity returns in early 2026 before it becomes clear which version of the economy actually shows up.

For now, the house is divided. When it reunites—whether around a growth narrative or a recession narrative—that clarity might finally allow markets to price with confidence. Until then, we live in the uncertainty in between.