Stock Rally Defies Fed Caution: Why Markets Expect More Rate Cuts Than the Central Bank Plans

The Federal Reserve delivered its widely anticipated move on Wednesday, trimming the benchmark federal funds rate by 25 basis points to a target range of 3.5%-3.75%. This marks the third rate cut of 2025, continuing the easing cycle that began last year as inflation retreated from decades-high levels. Yet beneath the surface of this routine decision lies a story of internal discord and sharply divergent expectations about what comes next.

A House Divided on Rate Policy

What’s truly striking isn’t the quarter-point reduction itself—it’s the unusual level of disagreement among policymakers. The Federal Open Markets Committee, which sets monetary policy, saw three voting members dissent from the majority decision. Two wanted rates to stay put entirely, while a third pushed for a more aggressive half-point cut. This kind of split hasn’t occurred in over a decade, signaling genuine uncertainty about the Fed’s path forward.

The Fed Pumps the Brakes on Future Easing

Jerome Powell’s leadership team is clearly signaling caution about additional rate cuts ahead. The committee’s updated statement employed distinctly careful language, emphasizing that future policy moves will depend heavily on economic data. More telling still: the Fed’s latest economic projections show the median expectation is for just one additional rate cut in 2026, followed by one more in 2027 to mark the end of the easing cycle entirely.

This represents a notably hawkish stance compared to what many in the market had anticipated.

But Wall Street Has Other Ideas

Here’s where the divergence becomes fascinating. Despite the Fed’s apparent reluctance to cut aggressively, equity markets surged—suggesting investors aren’t buying into the central bank’s conservative forecast. According to the CME FedWatch tool, which reflects how traders are pricing rate expectations, the consensus projection is for two rate cuts in 2026, not one. There’s even a 69% probability baked into market pricing for at least two cuts next year.

Why this optimism when the Fed seems so measured? Possibly because recent economic data has shown notable weakness, or because uncertainty surrounds leadership changes at the Fed in coming months. The tone of Powell’s press conference—far less cautious than some feared—may also have reassured markets that the door remains open to additional easing if conditions warrant it.

The Gap Between Fed Confidence and Market Conviction

The disconnect between the Fed’s projections and market pricing has become the defining tension in rate markets. While policymakers pencil in minimal future rate reductions, traders continue betting on two or more cuts by year-end 2026. This gap could be resolved in either direction: if the economy weakens further, markets may be proven right; if inflation remains sticky, the Fed may be prescient about holding the line.

For now, the stock market’s enthusiasm suggests investors believe economic weakness will eventually force the Fed’s hand, regardless of how cautiously its members currently speak.