Is the Federal Reserve's “infighting” in 2026 dangerous for US stocks?

The Zhitong Finance App learned that for more than a century, the stock market has been the core channel for wealth creation. Although other asset classes, such as bonds, commodities, and real estate, have all achieved value growth over the long term, no asset can match the stock market in terms of long-term annualized return.

2025 is an excellent example of how investors can be patient to reap great rewards. By the close of trading on December 5, the historic Dow Jones Industrial Average, the benchmark S&P 500 index, and the innovation-driven Nasdaq Composite had risen 13%, 17%, and 22%, respectively, since the beginning of 2025.

However, such a boom may be difficult to repeat in 2026.

Although there are always various negative factors that may drag down the main Wall Street indices, some potential risks are particularly rare. As 2025 comes to an end and the curtain slowly unfolds in 2026, the biggest threat facing Wall Street may come precisely from one of its historical stabilizing forces — the Federal Reserve.

The Federal Reserve is making history full of doubts

The Federal Reserve is tasked with formulating US monetary policy, with the core goals of achieving full employment and price stability. Under ideal conditions, the US unemployment rate should be at a historically low level, and the inflation rate should not exceed the central bank's long-term target of 2%. But the US economy is rarely in such an ideal state.

Federal Reserve Chairman Powell and 11 other members of the Federal Open Market Committee (FOMC) have various “policy tools” to influence the US economy through regulation to achieve the desired goals. One of the most widely known operations is to adjust the federal funds rate — a move that directly affects borrowing costs and may be indirectly transmitted to mortgage interest rates.

FOMC can also regulate long-term yields by trading long-term US Treasury bonds (note: bond prices and yields change in reverse).

At the end of October 2025, the FOMC voted 10-2 to cut the federal funds rate by 25 basis points to the 3.75%-4.00% range. Although this is not the first time that there has been a divisive FOMC vote, the rare disagreement that occurred at the October meeting made Wall Street and investors uneasy.

Federal Reserve Governor Milan is one of the two members who voted against it. He believes that the federal funds rate should be lowered by 50 basis points; while Kansas City Federal Reserve Chairman Schmid takes the opposite position and argues that no interest rate cuts should be made. This is the second time in 35 years that FOMC members have simultaneously raised objections in the opposite direction.

Wall Street and investors have always expected the Federal Reserve to provide stability, transparency, and policy coherence. However, due to US President Trump's differences with Powell over FOMC policy decisions, and Powell's term as chairman of the Federal Reserve expires in May 2026, this power to stabilize the stock market has gradually been transformed into a potential risk factor.

The Fed's policy signals are chaotic or ignite stagflation

Although the US economy does not move at the same time as the stock market, economic weakness usually leads to a decline in corporate profits, and strong economic fundamentals are often a necessary condition for the continuation of the bull market.

The core reason that US stocks may face a severe test in 2026 is that the components of stagflation have basically taken shape. Although Powell previously stated, “We have issued an early warning on the risk of stagflation, the US is not facing, and is not expected to face, this situation,” the current Federal Reserve is no longer the rock-solid pillar of stability as before.

For central banks, stagflation is the most difficult problem because there is currently no clear plan to deal with it. A typical characteristic of stagflation is the coexistence of high inflation and high unemployment, while economic growth stagnates or slows down.

If the FOMC chooses to cut interest rates to stimulate economic growth and employment, it may inadvertently push up the already high inflation rate; conversely, raising interest rates and raising borrowing costs may reduce inflation, but they may also exacerbate the problems of rising unemployment and slowing economic growth.

Since the Trump administration's tariffs and trade policies began to have an impact on the US economy, the inflation rate has risen markedly over the past 12 months — from 2.31% to 3.01% as of September 2025, according to the Urban Consumer Price Index (CPI-U) data. This inflationary pressure mainly stems from import tariffs, that is, imposing tariffs on imported semi-finished products to support the manufacture of domestic products. Import tariffs will increase costs for US producers, and these costs will eventually be passed on to consumers.

Meanwhile, the US job market is showing a slow but continuing weakening trend. The data on more than 100,000 new jobs initially released in May and June 2025 was drastically revised in follow-up reports; the unemployment rate of 4.4% in September hit the highest level since October 2021, up 100 basis points from the low of 3.4% in April 2023.

In terms of economic growth, the Philadelphia Federal Reserve and Fitch Ratings expect the US gross domestic product (GDP) growth rate to be 1.9% and 1.8% respectively in 2025, lower than the 2.8% growth record in 2024. Although this forecast still indicates that the economy is expanding, it also indicates that the pace of growth will slow down.

In other words, all the elements required for the formation of stagflation are in place, and there is currently only one trigger missing.

However, the appointment of the new chairman of the Federal Reserve in 2026 (probably a candidate who did not fully gain the trust of Wall Street), combined with ongoing differences of opinion among FOMC directors, may be the trigger for this risk, ultimately leading to a disappointing year for US stocks in 2026.