How a divided Fed could define the S&P 500 in 2026

Interest-rate cuts from the Federal Reserve and optimism over artificial intelligence have helped the stock market higher this year. A divided and changing Fed may complicate 2026.

Tuesday’s release of minutes from the Fed’s December policy meeting showed a split central bank, with three officials disagreeing with the decision to cut rates for the third time this year, the most significant dissent since 2019.

While the minutes also showed support for lowering borrowing costs more in 2026, traders see the odds of a rate cut in the first quarter as a coin toss.

Sentiment at the Fed seems as mixed as the economy, which shows signs of both surprising strength—though growth comes with inflation risks—and weakness, such as a cooling labor market.

Complicating matters is the end of Fed Chairman Jerome Powell’s term in May and the likelihood that President Donald Trump will nominate an acquiescent successor. Trump is worried about the cost of living but also wants lower interest rates, which are inflationary.

The Dow Jones Industrial Average is ending its best year ever on a points basis and the S&P 500 has seen a third year of around 20% gains. A repeat performance in 2026 is likely to need more rate cuts, but only if it doesn’t come with “stagflation,” a tough-to-navigate market environment where growth falters but inflation runs hot.

Uncertainty over rates also threatens that other pillar of the market: AI hype, which has fueled outsize gains for tech stocks. Fears of an AI bubble are guaranteed to linger. A bubble looks unlikely to burst while the Fed is cutting rates, but the outlook and pace of change for borrowing costs remains key for tech giants that have taken on piles of debt to fund AI sprees.

From trade policy that rocked the global economy to relentless AI surprises, this year more than many taught investors to expect the unexpected. But next year a divided Fed is something to bank on, and it could define the S&P 500 in 2026.