December 2024 FOMC Meeting Review
The Federal Open Market Committee announced a 0.25% rate cut at the December meeting, bringing the rate down to a range of 4.25-4.50%. This is a full 1.00% lower than when the Fed started making cuts earlier in the year. In their statement, the Fed implicitly acknowledged that economic growth has remained surprisingly strong and that unemployment has not increased as much as was expected earlier in the year. At the same time, they also noted that inflation remains somewhat elevated.
The rate cut was expected and wasn’t the news which drove the market action into the afternoon. Rather, the guidance accompanying the statement, coupled with comments from Chair Powell at his post-meeting press conference, saw the Fed effectively tapping the brakes on further rate cuts as we head into 2025.
The projections released today indicate the Fed now expects to end 2025 at a fed funds rate of 3.9% (the 3.75-4.00% range), which is only two cuts away. That took two cuts from the September projection off the table, which is a substantial revision for an entity which is typically slow to change their guidance. The Fed further expects rates to remain higher through 2026, ending at 3.4% versus the 2.9% prior estimate.
If a slower path to lower interest rates is the result, then one of the causes appears to be sticky inflation. The Fed previously expected PCE inflation to end 2026 at 2.1%, while Core PCE was expected to end at 2.2%. Today’s guidance puts both measures at 2.5% by the end of 2025 which is in line with (and slightly higher for PCE) than what the Fed expected for the end of 2024. They’ve effectively pushed the inflation recovery timeline by a year. In his press conference, Powell noted that the trend is still downward and progress has been made, but that progress has been slower than expected.
In addition to reviewing trends in economic data, Powell made clear that the economic policies of the incoming Trump administration are on the minds of the committee. Of course, poker-faced as ever, Powell could not be baited into providing a critique of those potential policies, keeping his commentary vague and pointing to how much of the policies and implementation are simply unknowable at this time, never mind the impact of those policies.
Markets reacted negatively to the guidance with the Dow shedding 2.58%, the S&P 500 2.95%, and the Nasdaq pulling back 3.56%.[1] All three indices were trading in positive territory in the morning prior to the Fed’s statement and guidance. Small caps fared the worst with the Russell 2000 pulling back 4.39%. It should be noted that these pullbacks are in the context of robust year-to-date returns which arguably may have gotten a little ahead of expectations.
Fixed income markets offered little respite at longer-dated yields climbed. The 10-year treasury has moved back above 4.5% and is only 0.20% away from the high for the year reached back in April. The rise in rates on a year-to-date basis is whittling away at bond fund total returns, but the higher yields have so far offset price losses due to higher rates and actually lift expectations for forward returns in fixed income. Short dated bonds were just about the only spot that mitigated losses today, but that is because yields have become less attractive on the short end due to Fed cuts.
How should investors interpret the market reaction?
That one is a little harder to figure out. On the one hand, we know that markets are discount calculators. That is, they take the future earnings of a company and discount them back at prevailing interest rates to come up with a stock price today. Higher rates imply lower present values due to the math. Coupled with a nervous market and historically high prices, it makes sense that the market would decline if rate expectations have moved higher.
On the other hand, the Fed is pausing, in part, because of economic strength. GDP growth is projected to stay resilient and projections have been updated slightly. Four months ago the fear was that unemployment was about to fall off a cliff, and now the Fed indicates that their expectation for employment is essentially stable as the unemployment rate is expected to tick up to 4.3% from 4.2% by the end of 2025 – that’s not much of a change. Looking at earnings, the S&P 500 is expected to deliver 10% growth for 2024 followed by an acceleration of growth in 2025 with growth currently projected at 14.2%.[2] A growing economy, stable labor market, and accelerating earnings growth is not an environment where you would expect the Fed to be cutting interest rates, and today’s statement and guidance seemed to confirm that.
So, valuations should be pressured by interest rates and should be helped by a fairly rosy economic outlook. We won’t know where the balance between the two lies until we get further down the road. In the meantime, attention will likely quickly shift away from today’s Fed action over to the potential for a government shutdown just in time for Christmas.
Please reach out to your advisor if you have any questions.
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[1] Google Finance, 12/18/2024
[2] Zacks Weekly Sector and Market Earning Trends, 12/18/2024