After a bruising 2025, the Fed faces another slew of challenges in the year ahead

• Wall Street economists predict 1-2 rate cuts in 2026 as the Fed aims to reach a neutral rate around 3%, with the current rate just 0.5 percentage points above the long-term target
• Political pressures intensify with a Supreme Court hearing on January 21 regarding Trump's authority to remove Fed Governor Cook, while Powell's term as chair expires in May
• Artificial intelligence emerges as a major wildcard for monetary policy, with the Fed needing to assess AI's impact on productivity and employment as the economy accelerates at a projected 3% pace

The Federal Reserve enters 2026 facing significant political and policy challenges, including leadership changes and complex economic conditions. Fed Chair Jerome Powell's term expires in May, with up to 11 candidates being considered for the position amid an interview process led by Treasury Secretary Scott Bessent.

President Trump has criticized Powell for not cutting rates faster and attempted to remove Fed Governor Michelle Bowser over unproven mortgage fraud allegations. A Supreme Court hearing on January 21 will determine whether Trump has authority to remove Fed governors. The FOMC meeting follows on January 28.

Despite political pressures, Wall Street expects the Fed to continue lowering interest rates toward the neutral level of approximately 3%. The federal funds rate currently sits just 0.5 percentage points above the long-term target. Market forecasts vary: the Fed's dot plot indicates one rate cut in 2026, while Nationwide's Kathy Bostjancic predicts two cuts (mid-year and year-end). Bank of America and Citigroup anticipate three cuts due to labor market weakness, while Apollo's Torsten Slok expects only one cut, citing economic strength.

The economy recovered from early 2026 weakness and is growing at a 3% pace in Q4, according to preliminary data. Major stock averages posted double-digit gains, driven partly by AI-related stocks.

Artificial intelligence presents both opportunities and challenges for monetary policy. RSM's Joseph Brusuelas emphasizes the Fed must communicate its strategy regarding AI's impact on productivity and employment as massive investments flow into these technologies.

Additional complications include multiple dissents at recent rate votes and incoming regional Fed presidents with hawkish views likely to resist further cuts.