The Federal Reserve's Internal Division Could Derail Stock Market Gains in 2026

Markets Rally While Policy Certainty Crumbles

The stock market has delivered exceptional returns to investors in 2025. Through early December, the Dow Jones Industrial Average surged 12%, the S&P 500 climbed 17%, and the Nasdaq Composite soared 22%. These impressive performances underscore the traditional role of equities as long-term wealth builders, outpacing bonds, commodities, and real estate.

Yet beneath this prosperity lies a troubling undercurrent. The greatest risk to continued stock market strength may not come from external economic shocks, but from an institution designed to stabilize markets: the Federal Reserve.

Unprecedented Dissent at the FOMC

The Federal Reserve’s mandate centers on two objectives: maximizing employment and maintaining price stability, with an inflation target of 2%. The Federal Open Market Committee (FOMC), led by Chair Jerome Powell alongside 11 other governors, wields powerful tools—particularly the federal funds rate, which influences borrowing costs and mortgage rates across the economy.

In late October, the FOMC reduced the federal funds rate by 25 basis points to a range of 3.75% to 4.00%, a decision that masked underlying fractures. The vote wasn’t unanimous. Fed Governor Stephen Miran pushed for a steeper 50 basis point cut, while Kansas City Fed President Jeffrey Schmid opposed any reduction. This represents only the second instance in 35 years where FOMC members dissented in opposite directions—a striking signal of disunity.

Investors typically view the Fed as a beacon of stability and consistency. That reassurance has eroded. With Jerome Powell’s term ending in May 2026 and speculation swirling about his replacement, combined with ongoing tensions between the White House and the central bank, the Fed has transformed from a stabilizing force into a source of uncertainty.

The Stagflation Puzzle Takes Shape

While Powell has publicly stated that stagflation remains unlikely, the economic conditions required for such a nightmare scenario are increasingly present. Stagflation—simultaneous high inflation, rising unemployment, and slowing growth—represents an intractable challenge for policymakers, as combating one element typically worsens another.

The tariff policies implemented by the Trump administration have already begun raising prices. The Consumer Price Index for All Urban Consumers (CPI-U) has climbed from 2.31% to 3.01% as of September 2025, primarily due to input tariffs on imported goods. These duties increase production costs for U.S. manufacturers, which are then passed to consumers.

Simultaneously, employment growth is showing cracks. Earlier job reports showing six-figure gains were significantly revised downward. The September 2025 unemployment rate reached 4.4%—the highest since October 2021 and a full percentage point higher than the 3.4% rate achieved just over two years earlier in April 2023.

On the growth front, economic forecasts have dimmed. The Federal Reserve Bank of Philadelphia and Fitch Ratings project GDP growth of 1.9% and 1.8% respectively for 2025, down substantially from the 2.8% growth achieved in 2024. While still signaling expansion, this deceleration foreshadows weakness ahead.

When Powell and the Fed Face Critical Decisions

The challenge intensifies when considering Jerome Powell’s speaking schedule and policy decisions approaching his departure from office. As markets digest the implications of potential Fed leadership changes, investors face a difficult 2026. A new chair lacking Wall Street’s confidence, compounded by continued FOMC divisions, could trigger the spark needed to transform current economic tensions into genuine stagflation.

The central bank’s traditional role as a reliable counterforce to market volatility has been compromised. Without clear, unified messaging from the FOMC and stability in leadership, the stock market’s historic returns could give way to disappointment.

Positioning for Uncertainty

For investors holding positions in the S&P 500 and broader equities, 2026 presents heightened complexity. The current bull market has been fueled by Fed accommodation and market confidence. That confidence is now fragile. The real question facing portfolios isn’t whether the stock market can continue climbing, but whether the internal divisions at the Federal Reserve and the economic cross-currents building beneath the surface will finally demand a reckoning.