Federal Reserve policymakers expect to raise their key rate to 5.1% next year, a rate higher than what Wall Street expects. The new projections, released at the end of Wednesday’s Fed meeting, were revealed along with an expected rate hike of half a point. The S&P 500 initially reversed sharply lower. Stocks hit lows but failed to sustain a rally after Fed chief Jerome Powell failed to hold the next rate hike to a quarter point.
Today’s rise in the 4.25% to 4.5% range came as the Fed eased its pace of tightening after four consecutive 75 basis point moves.
Prior to today’s Fed announcements, markets were pricing in a 60% chance of just a quarter-point hike on Feb. 1. This fell to around 47% shortly after the Fed’s announcement, but rebounded to 60% on Powell’s comments.
The Fed Chairman played down the importance of the size of the next hike, saying what matters is how high rates rise and how long they stay high. But he said it was too early to decide whether the next move would be 50 basis points or 25 basis points and Powell reiterated a few times that inflation risks remained weighted to the upside.
But the pace matters to investors, as it allows more time for further weak inflation readings or weaker jobs data to convince the Fed to halt rate hikes before they top 5%.
Powell added that he wanted to see “a lot more evidence” that inflation is under control. But he noted that “our policy is getting into a pretty good position.”
Fed meeting clarifies rate hike outlook
The new batch of quarterly projections from Fed policymakers show that the overnight rate will rise to 5.1% in 2023 and decline to 4.1% in 2024.
The Fed now expects the unemployment rate to hit 4.6% next year as growth slows to 0.5%.
Since his August speech in Jackson Hole, Wyoming, President Powell has stressed that the Fed will need to keep interest rates higher for longer, to minimize the risk of a protracted fight with high inflation, as in the 1970s.
Projections released after the September 21 meeting had indicated that the federal funds rate could reach 4.6% in 2023, before falling back to 3.9% in 2024. Powell later said that the maximum rate in the cycle of the Fed, or terminal rate, would likely rise above 4.6%.
In fact, markets had forecast a terminal rate of around 5.05% just ahead of Tuesday’s weaker-than-expected CPI inflation data.
But on the heels of CPI data, which showed core inflation rising just 0.2% last month, markets were pricing in a record 4.9% ahead of the January meeting. the Fed today.
Still, there was good reason to doubt that Fed Chairman Jerome Powell will be swayed by the more subdued readings of the consumer price index and core CPI inflation. In fact, Powell gave a speech on Nov. 30 explaining why these are the wrong inflation rates for the Fed to consider.
S&P 500 close to key level
The S&P 500 fell 0.6% in volatile afternoon stock market action after news of the Fed meeting and comments from Powell. That reversed Tuesday’s 0.7% gain, which narrowed after the S&P 500 climbed nearly 3% to Tuesday morning highs after the CPI low.
The Dow Jones Industrial Average fell 0.4% after the Fed meeting, while the Nasdaq composite lost 0.7%.
The S&P 500 broke above its 200-day intraday line on Wednesday for the second day in a row, before slipping below the key technical level after the Fed meeting policy statement. The latest rally attempts since April have stalled at the 200-day moving average.
All major indexes hit resistance at their Dec. 1 highs on Tuesday.
Through Tuesday’s close, the S&P 500 has rebounded 10% from its October 12 bear market closing low. Still, the S&P 500 remains 18% below its January 3 high. The Dow Jones has climbed 16.5% since hitting bottom, leaving it just 9% off its all-time high. The Nasdaq rebounded 6.6% but remains 31.5% below its peak.
Be sure to read IBD’s The Big Picture column after each trading day for the latest information on the current stock market trend and what it means for your trading decisions.
The US economy faces a hard landing – unless the Federal Reserve does
The Fed’s new key inflation rate
The specific inflation rate that Powell says the Fed and Wall Street should focus on comes from the Commerce Department’s monthly Personal Income and Expenditure Report, which tracks personal consumption expenditure, or PCE.
Powell’s new preferred inflation rate happens to be the most problematic for the S&P 500. The gauge factors in rapidly falling commodity inflation. It also excludes housing inflation, which looks set to decline in 2023 as government data catches up with stagnant growth in market rents.
This leaves only basic services other than housing, such as healthcare, education, hospitality and haircuts. Since changes in the prices of these services are closely linked to wage growth, they provide the best signal of the direction underlying inflation is heading, Powell said.
The Fed’s new key inflation rate is not good for the S&P 500 because it emphasizes the strongest part of the economy: the tight labor market. Until the labor market cracks, wage growth should remain stubbornly high and the Fed could raise its benchmark interest rate higher and for longer than markets expect.
The CPI report showed that prices for basic services excluding housing were stable in November compared to the previous month. But the similar PCE index will not be so tame. That’s partly because the two indexes measure healthcare inflation very differently, with the PCE measure more of a reflection of wage pressures. The CPI for medical services index fell 0.7% in November, the largest monthly decline on record.
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