Where is the Fed’s interest-rate policy heading?

The Fed’s Cautious Policy Foundation

The US Federal Reserve’s monetary policy outlook for the first half of 2026 is taking shape with a more cautious tone than financial markets had broadly anticipated. As the US economy demonstrated notable resilience throughout 2025, underlying fundamentals have given the Fed room to avoid rushing into policy easing. This stance was reflected in the decision on January 28 to keep the federal funds rate unchanged in a target range of 3.5%–3.75%.

In projections released in December 2025, 12 out of 19 Fed officials indicated that at least one additional rate cut would be appropriate this year.

According to analysis by experts at BSC Securities, US economic growth is expected to remain steady, supported by two main pillars: consumption and investment. Personal consumption, accounting for around 68.4% of GDP, continues to serve as the primary engine of growth. Data show that the personal savings rate has barely increased, indicating stable spending behavior among US households.

Notably, multiple data sources suggest that recent consumption growth has been driven largely by higher-income groups, who benefit directly from wealth effects stemming from financial markets and real estate. This group is less exposed to broader economic difficulties and therefore tends to maintain, or even increase, spending. As long as financial asset prices remain elevated, consumption by affluent households will continue to provide critical support for US economic growth in the year ahead.

Alongside consumption, investment is expected to play a growing role in GDP growth in 2026. With both the federal government and the corporate sector ramping up spending on infrastructure, energy, and especially artificial intelligence (AI)-related fields, capital investment has strong grounds to accelerate.

The key question now is when the Fed will resume cutting interest rates. In its December 2025 projections, 12 of 19 Fed officials still viewed at least one rate cut as appropriate in 2026.

The answer depends on which risk materializes first: a sharp deterioration in the labor market or a clear return of inflation toward the 2% target. Since December 2025, neither scenario has fully played out. Job growth has slowed noticeably, but the unemployment rate has stabilized. Inflation data, meanwhile, have been distorted by disruptions in data collection during the government shutdown.

According to BSC, while inflation has cooled significantly from its 2022 peak, price pressures in the US are likely to remain above the Fed’s 2% target throughout 2026. Two main drivers have been identified: one-off effects from tariffs and the persistent strength of aggregate demand.

Tariffs may generate a temporary price shock, but their overall impact is considered limited. First, food accounts for 14.4% of the CPI basket and is largely unaffected by tariffs, as US imports mainly come from Mexico and Canada under the USMCA. Second, housing costs, with a weight of around 36%, are not directly affected by tariffs. Third, roughly one-third of US imports consist of electronics that are exempt from tariffs.

Aggregate demand, however, remains the factor that warrants particular caution from the Fed. Rising income and wealth effects may continue to fuel consumption, while expansionary fiscal policy risks stimulating demand more than expected. Measures such as income tax cuts, annual tax refunds between January and April—estimated to inject around $100 billion directly into consumers’ pockets—and proposals to distribute $2,000 per person from tariff revenues could all prolong inflationary pressures. In this context, maintaining higher interest rates for longer is seen as a rational choice to ensure inflation returns sustainably to target.

“Regarding the labor market, the uptick in the unemployment rate toward the end of 2025 was seen as a key factor behind the Fed’s initial rate cuts. However, a deeper analysis suggests that this increase does not reflect a fundamental weakening of the labor market. The main reason lies in tighter immigration policies, which reduced the available labor force, while the number of unemployed workers did not rise significantly.

Looking ahead to 2026, with a positive growth outlook supported by stable consumption, the unemployment rate is expected to remain relatively steady. Only if initial jobless claims surge above the 270,000–280,000 threshold would the labor market risk a rapid downturn, forcing the Fed to implement sharper and more aggressive rate cuts,” BSC noted.

If the Fed Cuts Rates, Where Will Capital Flow?

From a banking and financial perspective, economist Dr. Nguyen Tri Hieu argues that given prevailing political variables in the US, rising political pressure, and growing demands to support growth, the Fed’s policy rate is likely to be cut by at least 0.5% over the course of the year, implemented in two strategically calculated phases.

First, before May 2026, the Fed may cut rates by 0.25% to ease political tensions and maintain short-term system stability. In the second phase, once a new Fed Chair is approved by Congress at the President’s recommendation, an additional cut of at least 0.25% is likely, formally launching a longer-term “easy money” cycle.

Notably, policy transmission would not rely solely on interest rates but could be amplified through quantitative easing (QE), with the Fed increasing purchases of US Treasuries, expanding its balance sheet, and injecting large-scale liquidity into the commercial banking system.

As the Fed funds rate declines, market interest rates are expected to adjust in a relatively clear sequence. Short-term interbank rates, such as overnight rates and LIBOR, would fall first, significantly improving system liquidity.

Next, benchmark rates for the corporate sector—particularly prime lending rates—would decline, directly reducing borrowing costs for business activity.

Finally, interest rates in the real economy, such as mortgages and auto loans, would fall sharply, stimulating household consumption. In particular, a proposed cap on credit card interest rates at 10% could deliver a substantial demand shock. The surge in money supply combined with lower borrowing costs would quickly reshape global asset pricing.

In a prolonged easy-money environment, the inverse relationship between the US dollar and real assets is expected to intensify. As expanding money supply erodes the dollar’s real value, international capital is likely to flow into safe-haven assets. Gold, despite already approaching historically high levels, is expected to continue breaking higher amid defensive demand against political uncertainty and currency debasement—serving not only as a return-seeking investment but also as a necessary hedge in 2026 portfolios.

At the same time, equity markets would benefit from lower discount rates and abundant liquidity, as companies enjoy reduced financing costs alongside stronger consumer demand, pushing stock indices to new highs. Government bonds would also gain support from direct Fed purchases under QE, benefiting both debt markets and public finances.

“However, history shows that strong financial market rallies often come with early warning signs of overheating in the real economy. A consumption-driven demand shock—particularly through personal credit—could push money circulation far beyond existing productive capacity, driving the economy into a difficult-to-control overheating phase. The risk of a sharp inflation spike is real, eroding household purchasing power, while pursuing easy-money policies for short-term political objectives could inflate risky asset bubbles.

More seriously, if the Fed’s independence is called into question and inflation remains unchecked, the US dollar’s role as a global reserve currency could be undermined, triggering significant volatility in global foreign-exchange markets.

As such, 2026 is expected to remain a highly volatile year. Policymakers and investors alike should prepare for multiple scenarios—from a baseline case of growth accompanied by gradually rising price pressures, to a negative scenario in which inflation resurges and forces the Fed into an abrupt policy reversal, or even scenarios of geopolitical and institutional instability that undermine confidence in the US dollar,” the expert warned.