The Federal Reserve appears positioned for an extended pause in interest rate cuts following December employment data that showed unemployment declining even as job growth remained modest. The mixed labor market signals provide policymakers with breathing room to maintain current borrowing costs as Chair Jerome Powell's tenure nears its conclusion.

December Employment Data Overview

The US unemployment rate fell to 4.4% in December from a revised 4.2% in November, according to the Labor Department's Friday report. However, employers added only 50,000 jobs during the month, falling short of the 60,000 gain economists had forecast.

Market Response and Rate Cut Expectations

The employment data has significantly shifted market expectations for Federal Reserve policy. Traders of rate futures now see just 44% probability of a rate cut by April, down from approximately even odds previously. Market participants view June as the more likely timeframe for resuming rate reductions.

Powell's term as Fed Chair concludes on May 15, with President Trump indicating he has selected a successor who supports further borrowing cost reductions. An announcement regarding the new Fed Chair is expected this month.

Labor Market Concerns Persist

Despite the unemployment rate decline, several indicators suggest underlying labor market weakness:

• Long-term unemployed (seeking work for more than six months) now represent over 25% of total unemployed individuals
• Part-time workers unable to find full-time employment increased sharply compared to recent months
• Annual job creation dropped dramatically to 548,000 in 2025 from approximately 2,000,000 in 2024

Economic Analysis and Fed Policy Implications

Olu Sonola, head of US economic research at Fitch Ratings, noted that the unemployment rate drop "should douse the Fed's recent urgency to backstop a weakening labor market." However, he emphasized that "weak headline job-growth story can't be brushed aside" as hiring remains at stall speed.

Pantheon Macro economists warned that "risks are skewed toward a pick-up in layoffs ahead," suggesting potential pressure for additional Fed easing while Powell remains in position. Current market pricing shows less than 30% probability of a March rate cut.

Outlook and Data Revisions

Benchmark revisions to labor market data expected next month are widely anticipated to show hiring was even slower than initially reported. Evercore ISI Vice Chairman Krishna Guha suggested the Fed "will remain very open to the possibility that underlying softening could still nudge the unemployment rate and other measures of slack higher again in the next couple of months."

The Federal Reserve reduced its benchmark overnight interest rate by 75 basis points in 2024 to prevent further job market deterioration, despite concerns from hawkish policymakers about potential inflation implications. The December employment data provides justification for the central bank's inclination toward maintaining current rates in the near term.

Bond traders have virtually eliminated their expectations for Federal Reserve interest rate cuts this month after December's unemployment data showed a stronger-than-expected decline. The robust jobs report triggered a selloff in US Treasuries, pushing yields higher across all maturities by as much as three basis points on Friday.

Market Response to Employment Data

The jobs report provided the first comprehensive view of employment trends following significant disruptions to data collection. A six-week government shutdown from October 1 to November 12 had delayed the production of labor reports for September, October, and November, making December's data particularly significant for market participants.

Despite the immediate market reaction, bond traders have maintained their broader outlook for monetary policy easing. Market participants continue to expect two rate cuts overall in 2026, with the first anticipated by mid-year.

Fed Policy Outlook

"This keeps us on course for them to slowly continue cutting the fed funds rates as we go through this year," said Robert Tipp, chief investment strategist at PGIM Fixed Income. "They are on the cusp of, or in the top end of, the neutral range. So they may feel like they are not having an impact on the economy, they can stand to skip a meeting."

The Federal Reserve has lowered its target band for short-term lending rates at its past three meetings in response to weakening labor-market conditions. However, some officials remain concerned about inflation staying above their target, which could limit the pace of further easing.

Labor Market Focus

The case for additional Fed interest-rate cuts depends heavily on labor market performance in the coming months. John Briggs, head of US rates strategy at Natixis North America, emphasized this connection: "For us, the Fed will key off the unemployment rate more than the noise in the headline, so this in my view is slightly bearish for US rates."

Treasuries gained more than 6% last year, marking their best performance since 2020, as investors anticipated signs of a cooling job market. Following Friday's report, traders are now pricing the next reduction for June, the month after Fed Chair Jerome Powell's tenure ends, with another easing expected in the fourth quarter.

Tariff Considerations

Beyond employment data, traders remain alert to potential developments regarding President Trump's tariffs. A possible court ruling on the legality of these levies could impact Treasury markets. The tariffs have generated hundreds of billions of dollars in revenue and helped ease pressure on the US budget deficit.

JPMorgan Chase strategists, including Jay Barry, noted that removing tariffs would likely "rekindle fiscal concerns, presenting a risk of higher long-term yields and steeper curves." However, they expect any impact to be "fairly limited," given the administration's ability to pursue alternative routes to restore most levies.