Stocks Plunge on Fed's Hawkish Outlook: Only Two Rate-Cut Expected Next Year
3min read Federal Reserve cut interest rates by 25 basis points, as expected. However, the market had already priced in this move. What truly drew attention was the updated dot plot and the revised economic forecasts for the coming year.
The Fed's Hawkish Outlook Surprises the Market
The Federal Reserve's hawkish tone exceeded market expectations significantly. The latest dot plot revealed that FOMC officials now expect only two rate cuts next year, down from the four cuts predicted in September. The average expected rate for 2024 is 3.9%, a substantial increase from the previous forecast of 3.4%. Additionally, not all members of the committee agreed with this rate cut, Cleveland Fed President Loretta Mester cast a dissenting vote, advocating for keeping rates unchanged.
In terms of economic forecasts, the Fed raised its inflation projections for 2025. The expected PCE (Personal Consumption Expenditures) and core PCE inflation for next year were revised upwards to 2.5% from 2.1% previously. This suggests that inflation remains well above the Fed's 2% target, and higher interest rates may persist for a longer period to control inflation.
Market Reaction: A Broad-Based Selloff
The market reaction to the Fed's hawkish stance was swift and dramatic. Risk assets across the board took a hit. U.S. stock indices all dropped by over 2%, with the Dow experiencing its 10th consecutive loss. The Nasdaq lost all of its gains from the past two weeks. The Magnificent 7 tech stocks, which had been the darlings of the market, all closed in the red.
The sell-off extended to precious metals, with gold and silver both experiencing sharp declines. Gold tested the $2600 mark, while silver fell by more than 3%.
The only asset to see significant gains was the U.S. Dollar, which surged 1% following the Fed's hawkish signals.
The Fed's Cautious Path Going Forward
During the press conference, Fed Chairman Jerome Powell addressed the central bank's future approach. He emphasized that after this rate cut, the policy rate had been reduced by a total of 100 basis points from its peak. The current stance is now much closer to a neutral rate, allowing the Fed to approach future rate changes with greater caution.
Powell noted that the current high interest rates are significantly restraining economic activity, and while the Fed is on a path to lower rates, further reductions will require more progress on inflation. He stated that the Fed remains committed to reducing inflation to its target level to help restore consumers' confidence and allow wages to keep pace with rising prices.
On the economy, Powell maintained that the U.S. economy is strong and resilient, avoiding a recession with a very optimistic outlook. FOMC officials now expect U.S. real GDP growth to be 2.1% next year, slightly higher than the 2.0% forecast in September. On the labor market, Powell acknowledged that while job growth is cooling, but is not fast enough to cause concern.
Powell also indicated that some policymakers are considering the potential impact of higher tariffs under a new Trump administration, though he stressed that the Fed has not incorporated this into its decision-making yet due to uncertainty about the specific nature of these policies.
Finally, Powell said that the Fed has no plans to add Bitcoin to its balance sheet, as the Federal Reserve Act does not permit the Fed to hold Bitcoin, and the Fed has no intention of seeking to modify the law.
Analysts' Perspectives: A More Cautious Path Ahead
Analysts have begun to digest the Fed's latest signals and are adjusting their expectations for future rate cuts. Nick Timiraos, often referred to as the New Fed Whisperer, pointed out that the Fed's statement now includes specific references to the degree and timing of future rate adjustments, suggesting a slower pace of rate cuts moving forward.
Brian Moynihan, CEO of Bank of America, expects the Fed to lower rates to 3.75%, with three more rate cuts on the horizon. He cautioned that the economy is stronger than it was three to six months ago, but there are still potential vulnerabilities that need to be addressed.
David Kelly, Chief Global Strategist at JPMorgan, forecasts three rate cuts next year. He believes the FOMC is laying the groundwork for a more cautious approach to monetary easing in 2024. Additionally, Kelly speculated that a newly elected Trump administration might put pressure on the Fed to relax its policy stance further, and the Fed may try to avoid clashes with the new government.
Conclusion: A Cautious Yet Hawkish Fed
In summary, while the Fed's rate cut was widely anticipated, the central bank's updated economic projections and dot plot revealed a far more hawkish outlook than the market had expected. This shift in stance has led to significant market volatility, particularly in risk assets. The Fed's focus will likely remain on controlling inflation, and further rate cuts are expected to be gradual. Investors will need to stay alert as the Fed's actions in the coming year could continue to have a profound impact on the markets.