Fed rate cut goes ahead, but 2026 outlook is less predictable

• US benchmark rate cut by 0.25 points
• Fed’s third reduction this year
• Welcome news for GCC, analysts say

The US Federal Reserve lowered its benchmark interest rate by 0.25 percentage points on Wednesday, its third cut this year and a move likely to support Gulf economies.

However, divisions within the Federal Open Market Committee, which sets the rate – as well as political manoeuvring against a backdrop of growing economic concerns in Washington – have cast doubt on the central bank’s direction next year.

In the GCC, where inflation remains subdued and five of the six member states peg their currency to the dollar, fresh US monetary easing will be welcome, according to Junaid Ansari, director of investment strategy and research at Kamco Invest in Kuwait.

That is especially true given “the sizeable projects in the pipeline” and the expectation that GCC governments will use bond or sukuk issuances to finance their development ambitions as oil prices remain low, he told AGBI. 

Saudi Arabia, whose budget deficit is rising as it undertakes a massive construction programme, stands to benefit the most from lower rates, Ansari said.

The central banks of Bahrain, Oman, Qatar, Saudi Arabia and the UAE broadly increase or lower their interest rates in tandem with the Federal Reserve. The Kuwaiti dinar is not formally pegged to the dollar, but is linked to a basket of currencies thought to be heavily weighted towards it.

On Wednesday, the Federal Reserve set the federal funds rate at a range of 3.5 to 3.75 percent in a divided 9-3 vote. It signalled that it might pause further action at its next meeting in January.

Ansari said he was expecting two rate cuts at most in 2026, because President Donald Trump’s tariffs could lead to higher prices for American consumers.

Lower rates could also feed into inflation in the Gulf, but analysts are not predicting this in the short term as food and energy prices are by and large controlled by the authorities in the region. 

Reductions “could keep the debt cycle going, raising future sustainability issues, especially for more indebted countries – Bahrain, of course, but I’m also watching Saudi Arabia”, said Rachel Ziemba, founder of advisory firm Ziemba Insights.

Trump is expected to continue insisting on lower rates regardless and has spared no criticism of Fed chair Jerome Powell over his cautious stance. 

Powell’s term is due to end next May, but the president plans to choose his successor in early 2026 – and has said he will only pick a candidate who is committed to further cuts.

​​”I do think the Powell tenure will get undermined early next year as the Fed chair in waiting is announced,” Ziemba said.

She is also on the lookout for surprises from the vote to reappoint the presidents of the United States’ 12 regional reserve banks – a typically routine process scheduled for February – and the annual rotation of those who have voting power on the Federal Open Market Committee. 

Some analysts worry that mounting political pressure on the central bank from the White House might undermine the Federal Reserve’s reputation for independence, and have cascading effects on the monetary policies of foreign states that follow its policy.

“Countries with a strong anchor to the exchange rate regime should care about a sudden loss of confidence in the US dollar coming out of the leadership transition in the Federal Reserve,” said Marcelo Giugale, an economist at Georgetown University.

Speaking at the launch of a World Bank assessment of the GCC economies this month, he said: “If markets were to say, ‘We really don’t trust the new chair,’ then we have a problem.”

Ansari is more sanguine.

“We do not believe that the Fed’s independence would be threatened given that it is a panel that decides rates, which includes mostly independent members,” he said.

“In addition, if the data does not support them, the rate cuts would be extremely difficult to implement and justify.”