The Federal Reserve cut its key interest rate for a third-straight meeting and penciled in two more rate cuts for 2025. The Fed meeting reveal was pretty much exactly what Wall Street expected, yet the S&P 500 turned sharply lower in Wednesday afternoon stock market action.
The Fed projections would see the federal funds rate cut to just below 4% next year, implying moderate additional relief from high rates for borrowers. However, markets continued to slide as Fed Chairman Jerome Powell spoke.
Most of what Powell said should have been soothing to markets, but one line stood out. Powell said that "policy uncertainty" relating to President-elect Trump's plans for tax cuts, tariffs and an immigration crackdown, provides another reason for the Fed to move slowly in further cutting rates.
Fed Projections Met With Doubt
The Fed cut its key interest rate 25 basis points to a range of 4.25% to 4.5%, as expected. On top of that, new quarterly Fed projections show a further 50 basis points in cuts in 2025, even as policymakers predict that the central bank's primary inflation rate, the core PCE price index, will only fall to 2.5%.
Ahead of the Fed meeting, markets were pricing in a year-end 2025 federal funds rate of 3.75% to 4%, which is exactly what Fed projects signaled.
Logically, there shouldn't have been much of a market reaction, particularly not in the bond market, since pre-Fed meeting pricing was right on the nose.
Yet after Fed Chair Powell's talk, Treasury yields jumped, as markets tilted toward just one quarter-point cut next year.
The Fed And Trump's Agenda
Powell has said that the Fed won't think about the implications of Trump's agenda for monetary policy until it becomes clear what those policies are. He added that while some Fed policymakers included assumptions about Trump's policies in their new economic and rate projections, others did not.
One possible interpretation of the market reaction is that the Fed is signaling just 50 basis points in rate cuts next year, even before factoring in the impact pro-growth tax and regulation policies from the incoming Trump administration.
Ignoring Trump's agenda makes the Fed projections of marginal value. The projections don't tend to be all that accurate anyway, even when fiscal policy, not to mention tariffs and a potential immigration crackdown, aren't in doubt.
The Fed's economic outlook for next year is pretty ho-hum, with 2.1% GDP growth and 4.3% year-end unemployment. Wall Street, by contrast, may see a continuation of solid economic growth ahead.
That suggests Fed projections about further rate cuts have a smaller margin of error. If the economy outperforms, still-elevated inflation will keep the Fed on guard, barring labor market weakness.
Fed Rate-Cut Odds
Odds of a January rate cut have fallen to 6%, while odds of a March 19 rate cut are now around 40%, according to CME Group's FedWatch page. Even for the May 7 meeting, odds of a rate cut have shrunk to right around 50%.
The upshot is that markets now see the Fed on hold until at least May, and maybe June.
"From here, it's a new phase, and we're going to be cautious about further cuts," Powell said.
Dovish Talk From Powell
The labor market is "clearly still cooling further," though gradually, Powell said. "The job-finding rate is low."
Powell reiterated that the labor market isn't a source of inflationary pressures, now that labor supply and demand are more in line.
He also said that the Fed's destination of a neutral interest rate, one that neither restricts nor propels economic growth, is still clearly below the current policy rate. Some on Wall Street have made the case that, after today's rate cut, the Fed is already at neutral.
Powell had been a bit more vague after the Nov. 7 rate cut, saying of the neutral rate, "We're pretty sure it's below where we are now."
S&P 500
The S&P 500 dived 2.95% on Wednesday, the worst drubbing in four months. The S&P 500 finished 3.6% below its Dec. 6 all-time closing high on Tuesday.
The S&P 500 is now up just 1.55% since Election Day, though still up 23.1% for the year.
The 10-year Treasury yield jumped 11 basis points to 4.49%, the highest close since May 31.
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