Today's (December 18th) significance in the stock market makes for a substantial event.
Today's (December 18th) significance in the stock market makes for a substantial event.
The US stock market is experiencing a remarkable year. The S&P 500 (^GSPC) has climbed an impressive 27% in 2024, positioning it for one of its top performances of the 21st century. This growth is largely due to speculations that the Federal Reserve will decrease interest rates multiple times before the end of 2025.
As of now, the futures market predicts three half-percentage point reductions by December 2025. However, some financial analysts are even more optimistic. Goldman Sachs forecasts three half-percentage point reductions by March 2025, while JPMorgan Chase predicts five half-percentage point reductions by December 2025. Yet, these estimates might be unrealistic considering inflation's recent acceleration.
Wednesday, December 18th, could be a significant day for the stock market. The Fed will not only announce an interest rate decision at 11:00 AM ET but will also update their long-term economic forecasts to provide insights into 2025. If these forecasts suggest fewer rate cuts than anticipated, the stock market could suffer a significant downturn.
The Federal Reserve's evolving monetary policy
The Federal Reserve is responsible for setting monetary policy that aims to ensure stable prices (stable inflation) and maximum employment. To achieve this, officials adjust the federal funds rate, a benchmark influencing various interest rates throughout the economy.
High interest rates decelerate economic growth by making borrowing less attractive, which leads to reduced inflation but increased unemployment. On the other hand, low interest rates stimulate growth by encouraging spending, which results in increased inflation but decreased unemployment.
Here's a timeline reflecting the Federal Reserve's recent monetary policy shifts:
- March 2021: Inflation, as measured by the Consumer Price Index (CPI), surpassed the Federal Reserve's 2% target. Covid-19's impact on supply chains, coupled with government stimulus, contributed to this occurrence.
- March 2022: The Federal Reserve lifted its benchmark rate for the first time since 2018. Many economists argued that the Fed had adjusted its monetary policy too slowly.
- June 2022: Inflation, as indicated by the CPI, reached 9.1%, recording its highest level since 1981. The Federal Reserve responded by intensifying its rate-hike cycle, which was the most aggressive in four decades.
- July 2023: The Federal Reserve raised the target federal funds rate to 5.25% to 5.5%, the highest level since 2001. Although not evident at the time, this marked the final rate increase in the tightening cycle.
- September 2024: The Federal Reserve reduced the target range by half a point, marking the first decrease since 2020. Officials projected three additional quarter-point reductions in 2024 and four quarter-point reductions in 2025.
- November 2024: The Federal Reserve reduced the federal funds rate by a quarter-point, bringing the target range down to its present level, 4.5% to 4.75%.
Federal Reserve officials last published their long-term economic projections at the September meeting, but their assumptions have since proven incorrect. They predicted a 2% increase in GDP for the year, but it skyrocketed to 2.8% in the third quarter. Officials also anticipated unemployment reaching 4.4% in 2024, but it peaked at 4.3% in July.
Fed Chairman Jerome Powell highlighted these inaccuracies in a recent interview. "The economy is robust, and it's stronger than we predicted in September," he stated. "Labor market growth is definitely more robust than we thought, and inflation is increasing again. So, the positive news is that we have some leeway as we try to discover neutral."
Inflation is moving in the wrong direction, which could prompt the Federal Reserve to revise its long-term projections
Recent inflation data adds uncertainty to the Federal Reserve's December meeting outcome. More specifically, after hitting 2.4% in September, CPI inflation has risen in two consecutive months, reaching 2.7% in November. Although in line with expectations, this indicates that consumer prices are moving in the opposite direction.
Similarly, the Producers Price Index (PPI) for final demand, which tracks inflation from the producer's perspective rather than the consumer's, bottomed at 2% in September. However, like CPI inflation, the PPI for final demand has increased in the subsequent two months, reaching 3% in November. This significantly exceeded expectations.
In conclusion, the futures market currently predicts three half-percentage point reductions in the federal funds rate before 2025, and some investors likely expect more. Indeed, the Federal Reserve anticipated four half-percentage point reductions in 2025 when it last updated its long-term economic projections in September.
However, the economy and labor market are stronger than anticipated, and inflation is climbing again. This will likely lead the officials to reconsider their long-term strategy. If the updated projections published today fail to meet investor expectations, the stock market could experience a sharp decline. Conversely, if the Federal Reserve's projections align with or surpass expectations, the stock market could rally.
With the Federal Reserve reconsidering its monetary policy due to inflation's upward trend, investors might need to reassess their investment strategies. This could particularly impact those who have been banking on the decrease in interest rates for their money-making ventures in finance and investing.
Given the Fed's evolving monetary policy and the unexpectedly strong economy, keeping a close eye on the stock market and its responses to the Fed's decisions becomes crucial. Accurate forecasting of the Federal Reserve's interest rate decisions and their implications on the economy can significantly impact one's investment portfolio.