The Schism at the Fed: What the December Minutes Reveal About 2026
Markets reopen tomorrow after a four-day holiday. The S&P 500 sits at 6,845. Wall Street's year-end targets for 2026 range from 7,100 to 8,100. Every analyst from here to Zurich is penciling in 11-17% gains. But before we buy that rally, we need to reckon with what the Federal Reserve's December minutes actually revealed: a central bank in genuine, substantive disagreement about the economy it's supposed to govern.
This is not routine dissent. This is structural conflict.
The Numbers Behind the Split
Seven officials projected no cuts in 2026, while eight forecast two or more reductions, with four supporting just one cut. Within a 19-member committee, that's a three-way split on the single most consequential question facing markets: the direction of monetary policy. Two weeks ago, the government reported that employers had cut about 40,000 jobs in October and November, while the unemployment rate rose to 4.6%, a four-year high.
Let that sink in. The Fed just cut rates three times in 2025, arriving at 3.5%-3.75%. Yet when policymakers project forward to 2026, they cannot agree on whether they should cut once, twice, or not at all—or even whether they should stay put.
This is what happens when the economy sends contradictory signals. Inflation should cool to about 2.4% in 2026, according to a December forecast from the Federal Reserve. But that would still leave inflation above the central bank's goal. Meanwhile, inflation remains above the Fed's 2% target, and the labor market is genuinely weaker than it was eighteen months ago.
The Fed faces its ancient dilemma in new form: jobs are softening, but inflation won't cooperate. You cannot cut aggressively without endorsing price gains that remain elevated. You cannot hold steady without risking demand destruction.
What the Minutes Actually Said
Some of the policymakers who were opposed or skeptical of the decision to cut rates in December "suggested that the arrival of a considerable amount of labor market and inflation data over the coming intermeeting period would be helpful on making judgments about whether a rate reduction was warranted."
Translation: some officials essentially said the December cut was premature. Even some Fed officials who supported the rate cut did so with reservations.
The market is currently pricing in a "Goldilocks" scenario—inflation that gradually cools while growth is sustained by AI investment—but the reality of a 4.5% unemployment rate and 3% inflation suggests a much narrower path for success.
The most revealing moment came from the committee's discussion of what happens next. Policymakers including Fed Chair Jerome Powell have suggested that the central bank's policy level is now closer to neutral and that further rate cuts may be on hold in the new year as they await fresh economic data.
Closer to neutral. Not restrictive. Not stimulative. Somewhere in between, hovering, waiting.
This shifts the entire 2026 narrative. The market had priced in the idea that the Fed, having cut three times in late 2025, would continue down a dovish path. The minutes suggest instead that the Fed has reached a resting point—a pause, not a pivot.
The AI Question Nobody's Asking (But Should Be)
If the minutes reveal that several governors are concerned about an AI-driven "asset bubble," it could trigger a tactical rotation out of high-flying tech and into more defensive or value-oriented sectors.
We don't yet know what the minutes will say on this subject. But we should be watching for it. A critical question for financial markets this year — are companies involved in AI overvalued — is likely to again take center stage in 2026. The Magnificent Seven have driven gains. Their valuations are elevated. If even one official on the committee uses the word "bubble," market positioning could shift overnight.
What This Means for January
As the markets reopen on January 2, the focus will immediately shift to the first major economic data points of 2026. The January jobs report and the subsequent inflation data will determine if the Fed stays on its "cautious easing" path or if a pause is necessary at the January 28 FOMC meeting.
The consensus expectation is that the Fed holds rates steady at the January meeting. In the short term, the January 2026 FOMC meeting is now widely expected to result in a "pause," with no change to the federal funds rate.
But what comes after depends entirely on the data. If unemployment ticks higher and inflation cooperates, the doves (led by Governor Stephen Miran, who argued for a larger 50 basis point rate cut in December) will have leverage to push cuts in March or June. If inflation re-accelerates or wage pressures flare up, the hawks will hold the line.
The Deeper Story
This isn't simply about January. It's about the transition from 2025 to 2026 as a shift from assumption to observation. Throughout 2025, markets operated on the assumption that the economy was solidly decelerating, inflation was on a glide path down, and the Fed would cut accordingly. That narrative got us to 6,845 on the S&P 500.
But the economy proved resilient in ways the consensus didn't expect. GDP growth accelerated. Wage growth slowed but remained positive. And here's the crucial part: inflation stopped falling once it got below 3%.
The Fed's job in 2026 is not to execute a predetermined cutting cycle. It's to watch new data in real time and adjust. The minutes make clear that 19 different people around that table have 19 different views of how much of the remaining inflation is temporary and how much is structural. They have 19 different views of what the neutral rate actually is. And they have 19 different thresholds for what constitutes intolerable weakness in the labor market.
What we saw in the December minutes is the Fed at a genuine fork in the road, unsure which path leads where. For investors who've spent eighteen months assuming Fed support would always materialize, that uncertainty is a meaningful change.
When markets reopen, they'll test whether 2026 can sustain the thesis that got us here: that earnings can keep growing at 15%+ even as the Fed sits on its hands. That the K-shaped economy continues to generate enough demand to keep growth and corporate profit margins intact. That we can thread the needle between inflation and unemployment without the pin breaking through.
Maybe we can. The baseline case still favors modest gains. But the Fed's minutes just told us, in the language it uses best, that nobody inside the system is confident that's how it plays out. They're all waiting for the data to show them the way.
That's the story markets need to process tomorrow.
The first five trading days of January have historically been strong predictors of the full-year performance. Watch the tape carefully. It'll tell you which Fed faction the market believes.