When the question of “why not?” stops working.
Last week, the Federal Reserve cut the target overnight lending rate by 25 basis points (0.25%) to an upper level of 3.75%. This wasn’t much of a surprise. The Fed was going to give us another rate cut whether we needed it or not.
But did we need it?
Since the Financial Crisis of 2008-2009, monetary policy has been decidedly different than it was in the past. Granted, the Fed has been trying to get back to some sense of normalcy since the end of 2022. However, what the inflation-neutral overnight rate should be is arguably anyone’s best guess right now. It has simply been that long since things were, well, conventional.
Even so, that isn’t going to stop folks like yours truly from throwing numbers at people. It is what we do.
Using quarter-end observations over the last 40 years, from 9/30/1985 through 9/30/2025, the trailing 12-month Consumer Price Index (CPI) has averaged 2.8%. Over that same period, the “upper bound” of the Federal Funds Target Rate has average 3.42%.
By this measure, voila, there you have it. A historical spread of 0.62%. As such, I can make a sentient argument that the inflation-neutral overnight rate is whatever the most recent trailing 12-month CPI plus, you guessed it, 0.62%.
Of course, true academics and members of the Federal Open Market Committee (FOMC) would argue there is more to it than that. The brightest bulbs in their box would crunch and otherwise manipulate the data in a myriad of complicated ways. However, do you want to know what the end result would be? Probably close enough to 0.62% to make it a little uncomfortable for anyone who spent a lot of time working on it.
So, let’s work this out.
The Bureau of Labor Statistics (BLS) estimated the trailing 12-month CPI was 3.0% in September 2025. Prior to last week’s FOMC meeting, the target overnight rate was 4.00%. Obviously, that is a spread of 1.00%.
Equally as obvious is that the current difference is greater than the historical average I mentioned above. This, by 0.38%. As such, prior to last week, the Fed had anywhere from 0.25-0.50% worth of rate cuts left to remain within a reasonable variance of the norm.
Put another way, the Fed wasn’t in danger of making monetary policy too “loose” with a 25-basis point (0.25%) cut. So, why not? Hey, please don’t think the decision-making process is always as tight as a drum or far more sophisticated than that.
Writing that last paragraph reminded me of a weird situation I had close to 15 years ago. I was providing lunch for the entire office of a client of ours, and they said an assortment of sandwiches from a nearby sub shop would be fine.
When I pulled up at 11:15 to pick up the food for my 11:30 meeting, they hadn’t started working on my two dozen sandwiches. Incidentally, I had ordered them to be ready at 11:00. In any event, the apparent owner of the place came out from the back, and the following ensued.
Hey…Mr. John. We make good subs just for you.
Okay. How fast can you make them? I am kind of pressed for time.
Hey…Mr. John. No problem. We make them fast just for you.
Great.
Hey…Mr. John. You want meatball subs? Hey…what am I asking? Who doesn’t want a meatball sub? Am I right, Mr. John?
Yeah, sure. I’ll take a couple of meatball subs. Why not?
Hey…Mr. John. Why not?
Now, I am not saying ordering meatball subs in Childersburg, Alabama, carries anywhere near the same level of gravitas as cutting the overnight rate. Clearly. Still, I suspect my decision-making process back then wasn’t too different from that of some of the folks on the FOMC.
I freely admit that sounds beyond cynical.
However, how many people reading this newsletter have ever been on a committee? Better yet, multiple committees? Now, how many of those committees were prone to some measure of groupthink? Further, how many of you have ever voted with the majority because your personal conviction wasn’t strong enough to vote against it?
To be sure, the FOMC is an incredibly important committee. However, that doesn’t mean it is immune from behaving like, well, a committee.
That is why I suspect the decision to go from 4.00% to 3.75% wasn’t terribly contentious for some participants. A small cut can reasonably be viewed as a way to narrow the gap without materially altering the broader stance of policy. In and of itself, it isn’t that big of a move. I mean, it wasn’t like the decision was to go from 4.00% to 2.00%. No one would have voted for that drastic of a cut. No way.
But if the so-called neutral rate is closer to 3.50% than 4.00%, and we are sitting at 4.00%, what is the harm with making a small cut? You know, splitting the difference for the time being?
No need to make waves so close to the holidays.
For me, the bigger news coming out of the meeting was the Fed announcing that it is going to purchase $40 billion worth of shorter-term Treasury debt each month through April 2026. The exact verbiage in the implementation note was:
On December 10, 2025, the Federal Open Market Committee (FOMC) directed the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York to increase System Open Market Account (SOMA) securities holdings to maintain an ample level of reserves through purchases in the secondary market of Treasury bills (or, if needed, of Treasury securities with remaining maturities of 3 years or less). These reserve management purchases (RMPs) will be sized to accommodate projected trend growth in the demand for Federal Reserve liabilities as well as seasonal fluctuations, such as those driven by tax payment dates.
Monthly amounts of RMPs will be announced on or around the ninth business day of each month alongside a tentative schedule of purchase operations for the subsequent approximately thirty days. The Desk plans to release the first schedule on December 11, 2025, with a total amount of RMPs of approximately $40 billion in Treasury bills; purchases will start on December 12, 2025. The Desk anticipates that the pace of RMPs will remain elevated for a few months to offset expected large increases in non-reserve liabilities in April. After that, the pace of total purchases will likely be significantly reduced in line with expected seasonal patterns in Federal Reserve liabilities. Purchase amounts will be adjusted as appropriate based on the outlook for reserve supply and market conditions.
While the Fed has tried to distance this action from a true “quantitative easing” program, to some of observers the distinction may feel more semantic than substantive — to quote The Bard — “A rose by any other name would smell as sweet.” Until it convinces me otherwise through meaningful action, I remain skeptical that the Fed is going to be in any hurry to shrink its balance sheet. Based on current conditions and past behavior, that process appears more likely to be gradual and limited rather than swift or decisive.
So, what does that mean in practical terms? Potentially $200 billion in additions to the balance sheet through the end of April? They aren’t going anywhere, no matter what the Fed might say to emphasize the temporary nature of the action. No way. History suggests they are there for longer than initially anticipated and suggests contraction is likely to be challenging in this environment. No more quantitative tightening for thee, me, we, she or he.
Shoot, it would be a material departure from my current expectations if the Fed shrinks its balance sheet by that amount, that $200 billion, by the end of the third quarter of 2026, I might let my co-worker Jim Williams hit me in the face with a pie. One from the refrigerator, not the oven.
In fact, while that outcome is certainly possible, it does not appear to be the most likely path based on current policy signals. I would submit that the harder decisions, the ones committee members will have to spend serious time making, will involve the size of the Fed’s balance sheet more so than the overnight rate. They won’t be able to shrug and say, “Why not?”
In fact, I submit “we” will spend as much time, if not more, wondering how much the Fed will increase the size of its balance sheet at each FOMC meeting than what it intends to do with the overnight rate.
At that time, we will start thinking about the so-called neutral rate in terms of billions of dollars as opposed to basis points.
So much for normalcy.
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this and every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
John Norris
Chief Economist/Chief Investment Officer, Oakworth Asset Management
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