iCapital Market Pulse: January Macro Playbook: Setting Up the Pause

Key Takeaways:

• Federal Reserve is likely to pause rate cuts early in 2026, similar to last year
• Labor markets show signs of stabilization, while inflation remains a wild card – seasonal factors and a payback from the government shutdown could keep upcoming prints sticky
• A pause could put upward pressure on rates in the near-term, supporting cyclicals but potentially weigh on small caps and rate-sensitive sectors
• In private markets we would favor infrastructure, while the current environment should support private credit’s yield advantage relative to public market

To return policy to a more neutral stance, the Federal Reserve lowered its policy rate by 75 basis points (bps) in 2025.¹ As we enter 2026, however, the Fed has signaled an increased likelihood of pausing further rate cuts. This was confirmed in the latest Fed minutes and by comments from John Williams who stated: “No sense of urgency to act further on monetary policy.”²

This pause would be similar to what was experienced at the start of last year. Coming into the year, the inflation trajectory remains a wild card, and the disagreement on the Federal Open Market Committee (FOMC) may only worsen with more hawkish members joining.

Markets are currently priced for a pause, as the first full rate cut is not expected until June 2026.³ But, we still think a delay in further cuts could put upward pressure on rates in the near-term. Looking at the pause last year, the 10-year Treasury yield increased by roughly 30bps through most of January. Historically sharp increases in yields have weighed on equity markets. However, we still believe markets can perform well, as a pause often signals resilient growth, stable labor markets, or inflation moving back toward target. Looking back at prior Fed pauses, the S&P 500 increases by 3.6% in the 3-months after a pause, which compares to the 2.6% rolling 3-month average going back to 1989.⁴

The duration of the pause will ultimately be determined on how labor and inflation data unfold.

The Debate Between Inflation and Labor Continue

With the Fed likely set up for a pause, as discussed in our 2026 Market Outlook, we believe the debate between labor and inflation will continue in the new year.

For the Fed to return to a rate cutting stance, it will ultimately hinge on the trajectory of labor markets. If labor markets continue to weaken, it will become more challenging for the Fed to get ahead of further weakness – falling behind the curve would likely not be market positive and fall under our definition of “bad cuts”.

However, green shoots appear to be forming in labor markets. Specifically, high frequency indicators are starting to stabilize – notably the weekly ADP time series, though we would note the data is still noisy. Another indication is the pick-up in private payrolls, with the 3-month trend rising to 76K, up from 13K in August (as seen in Exhibit 1).

We feel it is important to monitor private payrolls at this juncture because headline job growth is being impacted by the reduction in force for federal government jobs. Indeed, since 2025, federal government jobs have declined by -268K.⁵ Despite this weakness, we still appear to be operating in a “low hire, low fire” job market, as initial jobless claims have followed their seasonal pattern and remain near their lowest level going back to 1970 (as seen in Exhibit 2).⁶

Inflation on the other hand remains a bit of a wild card. The latest reading showed a sharp drop towards the Fed’s target – declining to 2.6% year-over-year (YoY) from 3.1% YoY. ⁷ However, there are two reasons to believe this print may be artificially low.

1. Shelter cost imputations were low. Shelter costs were assumed at 0%, which is below the average of 0.3% month-over-month (MoM) in 2025 and the 0.4% MoM average for November going back to 2020 (as seen in Exhibit 3).⁸
2. Prices were collected in the second half of the month. This could likely reflect larger holiday discounts, which likely kept the reading low.

We expect inflation to continue back towards the Fed’s target in 2026 but think it will happen at a gradual pace. Indeed, given the November print, we could see some payback later in 2026. In addition, we know that January tends to be a “hot” month for inflation, as January has averaged 44bps month-over-month (MoM) going back to 2020, 12bps higher than the 32bps average for all other months over that timeframe.⁹  Therefore, seasonal factors may also support a pause in the Fed’s rate‑cutting cycle, similar to what occurred in 2025.

But the Focus Will Shift to the Fed Chair Announcement

While incoming data will dictate the path of policy, the upcoming Fed Chair announcement will likely have more of an impact on market pricing, especially in the second half of the year.

Currently, the two Kevins – Hassett and Warsh – are favored, with their odds standing at 40% and 39%, respectively (as seen in Exhibit 4).¹⁰ Based on recent speeches and interviews, it seems like both candidates would support easier policy, which could present downside risks to current market pricing of the one rate cut that is priced in from June to December 2026.¹¹

Hassett: “If you look at central banks around the world, the U.S. is way behind the curve in terms of lowering rates”¹²

Warsh: “We can lower interest rates a lot, and in so doing get 30-year fixed-rate mortgages so they’re affordable so we can get the housing market to get going again.”¹³

This could create an interesting tug-of-war in the near-term as it essentially creates a lame duck period for Chair Powell. Given the likely pause – barring any significant changes to incoming data – markets may care more about the comments from the newly nominated Fed Chair, which could ultimately impact Treasuries and market pricing for expected policy changes.

Market Implications: Maintaining a Cyclical Bias

With growth holding up, signs of labor market stabilization, and the potential for hotter inflation prints in the near term, this could put upward pressure on both short- and long-term rates while the Fed remains on pause. This environment should continue to support cyclical sectors, though it may weigh on small caps and other interest-rate-sensitive areas. We are closely monitoring small caps, which have outperformed the S&P 500 by roughly 1.5% since the Williams speech in November that helped set up the December rate cut.¹⁴

In private markets, while many of these factors discussed above are short-term in nature, we would continue to favor infrastructure. Given the fact that inflation could remain sticky to start 2026 – seasonals plus a payback from the government shutdown – inflation is projected to remain above target. Historically, in this environment, infrastructure and real assets tend to outperform the returns of a Global 60/40 portfolio (as seen in Exhibit 5, a chart from iCapital Alternatives Decoded).

Beyond that, several secular tailwinds – particularly in areas like digital infrastructure (data center buildout) and the energy transition – should support both existing investors and new investors in upcoming vintages. 

Elsewhere, if the macro backdrop holds and base rates stay near current levels, private credit should retain its yield advantage over public market counterparts. While there were several idiosyncratic issues during the fall of 2025, we have seen fundamentals improve. Notably, non-accruals remain below their 10-year average and payment-in-kind as a percentage of income has declined.15