The path of US interest rates has big implications for investors across the globe given the implications this has for the world’s largest economy and financial market.
After a quarter percentage point cut was delivered on 10 December, attention turned to what is in store for 2026, a year which will see current Federal Reserve chair Jerome Powell replaced.
What will happen with US interest rates in 2026?
Alongside its latest decision on interest rates, the Fed raised its 2026 GDP growth projection by 0.5% to 2.3%.
Consequently, the central bank now sees just one quarter of a percentage point cut in interest rates in 2026 and another one in 2027.
It is worth pointing out there was a wide divergence of views among officials, not just about the magnitude, but also the direction of interest rates.
Meanwhile, market implied expectations imply roughly two quarter percentage point interest rate cuts in 2026. This investor outlook was given credence by a raft of recent data from the US, some of which had been delayed by the government shutdown.
This included a lower-than-expected reading of US inflation. The latest CPI number, announced on 18 December, showed prices rose 2.7% over the 12 months to November. That pace was down from 3% in September and materially lower than the 3.1% forecast by analysts.
Employment data released on 16 December showed the US economy lost 105,000 jobs in October followed by a small rebound in November with 64,000 jobs created compared with the 50,000 expected by economists.
The closely watched unemployment rate rose to 4.6%, higher than had been anticipated. Retail sales data for October undershot expectations, coming in flat month-on-month and marking the lowest reading in five months.
What is happening with government bond yields?
Previous interest rate cutting cycles in the US have tended to drive yields on government bonds (also known as treasuries) lower, so it is noteworthy that the current cycle is not following the same pattern.
The Fed has lowered official interest rates by a total of 1.75% since September 2024 to the current level of 3.6%, but 10-year bond yields have risen by around half a percentage point over that timeframe.
This is highly unusual. JPMorgan points out that the during the previous seven rate cutting cycles going back to the 1980s the yield on the 10-year treasury fell every time within 100 days after the first rate cut.
The chart below shows the path of two-year treasury yields, which are a good proxy for US interest rates, against 10-year yields.
Could the Fed’s independence be threatened?
The path for interest rates and bond yields hinge not only on the state of the economy but also potentially on who is the next chair of the Federal Reserve.
President Trump has consistently criticised current chair Jerome Powell for not cutting interest rates more aggressively. Powell’s term ends in May 2026 and Trump is expected to name his successor in early 2026.
Concern about Fed independence could push long-term bond yields higher as investors demand a premium for the risk of higher inflation. Yields could also move higher because of concerns over high and persistent budget deficits and rising national debts.
This is referred to as the “term premium” which reflects the compensation investors demand for holding longer dated treasuries amid higher uncertainty.
Why is the 10-year treasury yield so important?
The 10-year treasury yield serves as a benchmark for long-term borrowing costs. This can influence mortgage rates, corporate borrowing costs and asset valuations.
The 10-year treasury yield serves as a global risk-free rate and is often used to value future cash flows for equities. A higher rate leads to lower theoretical stock valuations, particularly for growth stocks whose cash flows are further in the future.
Martin Gamble: Shares and Markets Writer
Martin Gamble is Shares and Markets writer at AJ Bell. He was previously the Education Editor of Shares Magazine. He has been with the business since 2019.
Martin graduated from the University of Kent in...
