Federal Reserve Chairman Jerome Powell holds a news conference following a two-day meeting of the Federal Open Market Committee in Washington, Dec. 10, 2025.
Kevin Lamarque | Reuters
The Federal Reserve faces a number of policy challenges in 2026, led by a new chairman and an economy fueled by both tailwinds and headwinds, which will make policymakers' decisions all the more important.
After three consecutive rate cuts, the central bank is expected to adopt a more dovish stance next year, although further rate cuts are likely to be difficult given expectations of solid growth and persistent inflationary pressures.
One thing seems certain: After a year of extraordinary upheaval surrounding the Fed, 2026 looks set to offer more of the same.
“I think there will be a lot of spotlight. There will be a lot of intrigue,” said Kathy Bostjancic, chief economist at Nationwide. “There is still a lot of uncertainty that keeps the Fed in the spotlight, and probably in the hot seat.”
Last year, the Fed came into the spotlight in an unprecedented way.
As he began his second term in the White House, President Donald Trump repeatedly threatened to fire Fed Chairman Jerome Powell because he did not push for interest rate cuts more quickly. Around mid-year, the Fed came under fire again, this time for cost overruns on a renovation project it was undertaking at its headquarters in Washington.
At one point, Trump tried to oust Gov. Lisa Cook because of allegations that she had committed mortgage fraud, as yet unproven and not yet officially made. This all came amid questions about who would succeed Powell as chairman when his term expires in May. Up to 11 candidates were considered in an interview led by Finance Minister Scott Bessent.
If this all sounds exhaustive, consider that 2026 begins with a Supreme Court hearing scheduled for January 21 to decide whether Trump has the authority to remove Cook. A week later, the Federal Open Market Committee holds its interest rate vote. Trump is expected to announce his pick for Fed chair sometime later this month. And Powell, who has been reticent on the matter, must also reveal whether he intends to serve his term on the Board of Governors, which runs until January 2028.
There have also been plenty of disagreements in recent rate votes, and the new regional presidents set to come on board at the FOMC have a hawkish bias, meaning they are likely to resist further cuts.
“It’s still a difficult situation for the Fed,” Bostjancic said.
Focus on politics
When it comes to monetary policy, however, most Wall Streeters expect the Fed to silence the noise and continue to cut its key interest rate a little further until it approaches a neutral level of around 3%. Neutral is considered a point that neither stimulates nor slows down economic activity, and the federal funds rate is only half a percentage point above where most FOMC members expect the rate to be in the long run.
“Chairman Powell helped orchestrate three 25 basis point rate cuts in a row. It's not like he stood in the way of the FOMC rate cuts,” Bostjancic said. As for further cuts: “For us, it is.” [about] the economic data.”
According to Bostjancic, the data suggests two cuts this year, one around the middle of the year and another towards the end. The Fed's “dot plot” expectations grid only points to one cut, while outliers like Moody's Analytics chief economist Mark Zandi and Citigroup point to labor market weakness at three.
Powell and his colleagues are convinced that they will not be pressured into cuts and will actually be guided by data.
Torsten Slok, chief economist at Apollo Global Management, believes the economy will be too strong for the Fed to cut rates further, with only one more rate cut to come.
“The problem is that the winds are really changing for the U.S. economy,” Slok said in a CNBC interview on Friday.
While tariffs, inflation and general uncertainty prevail in 2025, fiscal stimulus and a stabilizing labor market would boost growth, he said.
“In my view, it looks more like the tailwinds are starting to strengthen and make it more difficult for the Fed to cut rates this year,” Slok added.
The role of AI
A wild card will be the role that artificial intelligence plays in economic growth.
Joseph Brusuelas, chief economist at RSM, said assessing the impact of AI on the economy will be paramount for the Fed, as it represents both a productivity booster and a potential barrier to hiring.
“The Fed faces a real challenge this year in terms of communicating its strategy,” Brusuelas said. “These huge investments are going into advanced technologies, and the Federal Reserve needs to share its fundamental view of what that means.”
After a sputter at the start of 2026, the economy grew rapidly in the middle two quarters and is expected to rebound by 3% in the fourth quarter, according to preliminary data from the Atlanta Fed.
In addition to helping to boost the overall economy, AI-related stocks were a key highlight of another stellar year on Wall Street, with major averages posting double-digit gains.
Adjusting monetary policy in such an environment will be difficult, Brusuelas said.
“They need to provide strategic direction to the central bank at a time when the economy is clearly focused on integrating this sophisticated technology into the production of goods and the provision of services,” he said. “This is a really big potential policy game changer that needs to be implemented.”