Fed Cut, Tight Credit, and a Market Priced for Certainty

Beneath flat indexes, capital is already repositioning for 2026.

Key Highlights

• Indexes stayed calm, but leadership shifted meaningfully.
  Mega-cap technology paused while cyclicals, financials, and defensive sectors quietly assumed leadership, signaling rotation rather than broad market weakness.

• The Fed cut rates, but certainty did not increase.
  Policymakers eased again while emphasizing data dependence, leaving markets to reconcile lower inflation with a less predictable policy path into 2026.

• Credit markets remain priced for near-perfection.
  Investment-grade and high-yield spreads sit near cycle lows, suggesting confidence in a soft landing but offering little margin for error if growth falters.

• Global policy divergence is back.
  The Fed, ECB, BOE, and BOJ are now moving in different directions, reinforcing the case for selective global exposure rather than uniform risk-on positioning.

• Market breadth is improving, not deteriorating.
  Smaller stocks, value sectors, and international equities are participating more, reducing reliance on a narrow group of mega-cap leaders.

• Low volatility may be misleading.
  Suppressed volatility and tight spreads suggest calm conditions, but historically have also preceded sharper repricing when expectations shift.

• The transition into 2026 favors selectivity over momentum.
  The market appears to be moving from a one-trade environment toward a phase that rewards diversification, discipline, and active risk management.

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Markets closed the final full week before the holidays in a state of uneasy balance. Major U.S. equity indexes finished little changed, masking a meaningful internal rotation beneath the surface. Investors digested a softer inflation print alongside a Federal Reserve rate cut that came with unexpectedly hawkish guidance on the pace of future easing. The result was a tug-of-war between optimism and restraint: mega-cap technology stocks stalled, while cyclicals, financials, and defensive sectors quietly gained ground. The so-called Goldilocks narrative remains intact, but it is increasingly conditional.

Macro Signals: A Cut That Clarified Little

The Federal Reserve delivered a widely anticipated 25-basis-point rate cut at its final meeting of the year, marking the third reduction of 2025. Chair Jerome Powell was careful to emphasize uncertainty, noting that inflation remains above target and that further cuts in early 2026 are not assured. The message was clear: policy is easing, but the Fed is not on autopilot. Bond markets reflected that ambiguity. Short-term yields declined modestly, while longer-term yields initially rose before settling, leaving the 10-year Treasury hovering near 4.15 percent by week’s end.¹

Economic data reinforced the Fed’s cautious stance. November CPI surprised to the downside, showing inflation rising at its slowest year-over-year pace since early 2021.² Labor market data, delayed by earlier government disruptions, pointed to gradual cooling rather than collapse. Payroll growth rebounded modestly, but the unemployment rate edged higher, suggesting incremental slack is forming. Together, these trends support a late-cycle slowdown narrative without yet confirming recessionary conditions.³

Globally, central bank paths continue to diverge. The European Central Bank held rates steady, signaling patience rather than imminent easing. The Bank of England opted for a rate cut, while the Bank of Japan raised rates to levels not seen in decades. This lack of synchronization underscores a key risk for 2026: monetary policy will increasingly reflect local conditions rather than global coordination.

Equities: Rotation Over Retreat

Headline equity performance understated the week’s volatility. The S&P 500 briefly broke below its 50-day moving average midweek before rebounding, while the Nasdaq underperformed as investors took profits in technology and AI-linked names. The pressure was concentrated. Equal-weighted indexes, value stocks, and cyclicals fared far better, suggesting the market is rotating rather than unraveling.⁴

Technology’s pause reflects valuation sensitivity more than structural weakness. News surrounding elevated capital spending requirements for AI infrastructure heightened investor scrutiny over near-term earnings leverage. Meanwhile, consumer discretionary stocks delivered mixed signals. Strong holiday spending data supported retailers, but Nike’s earnings highlighted persistent margin pressure and weak demand in China, triggering a sharp selloff in the stock.⁵

In contrast, industrials and financials emerged as relative leaders. FedEx’s earnings beat and guidance upgrade reassured investors that global trade and logistics demand remain resilient.⁶ Banks benefited from a modest steepening of the yield curve and the perception that net interest margins may stabilize. Energy stocks lagged, weighed down by falling oil prices as inventories rose and geopolitical risk premiums eased.

Defensive sectors fulfilled their traditional role. Utilities, consumer staples, and healthcare held up well during the midweek drawdown, reflecting investor preference for earnings stability amid policy uncertainty. Market breadth improved notably, with a larger share of stocks trading above key moving averages and small-caps beginning to outperform mega-caps on a relative basis.⁷

Global Markets: Europe Gains, EM Diverges

European equities quietly delivered one of their strongest weeks of the year. The STOXX 600 reached record highs, supported by easing inflation, attractive valuations, and strong performance in financials and defense stocks.⁸ Capital flows suggest global investors are increasingly reallocating away from expensive U.S. growth stocks toward Europe’s more cyclical and value-oriented markets.