Wall Street Braces for a More Cautious Federal Reserve in 2025

Federal Reserve Chairman Jerome Powell prepares to deliver remarks in Washington, on Nov. 8, 2023. Chip Somodevilla/Getty Images

A more cautious and conservative Federal Reserve will likely influence Wall Street’s playbook for the new year.

At the December policy meeting of the Federal Open Market Committee (FOMC), Fed officials signaled to the financial markets that they would pursue a slower path of easing through 2025. Retail traders and institutional investors were unhappy, although market watchers widely anticipated a more methodical approach to normalizing interest rates amid renewed inflationary pressures.

Panic hit the New York Stock Exchange when the Fed updated the Summary of Economic Projections. The quarterly survey revealed that policymakers anticipate two quarter-point interest rate cuts next year, down from the previously penciled-in four reductions to the benchmark federal funds rate.

Policymakers predict the median policy rate will reach 3.9 percent by the end of next year, down from the current range of between 4.25 percent and 4.5 percent.

Federal Reserve Chair Jerome Powell conveyed to the financial markets that inflation risks are higher than when the central bank launched the easing cycle in September.

“As we think about further cuts, we’re going to be looking for progress on inflation,” Powell said. “We have been moving sideways on 12-month inflation.”

Indeed, officials raised their personal consumption expenditures price index inflation target to 2.5 percent for next year from 2 percent. Powell said that it could be another “year or two from here” before the institution reinstitutes its 2 percent inflation objective.

The CME FedWatch Tool shows that the futures market predicts that the FOMC may take a break at the January policy meeting. Investors seem to be looking for the next rate cut at the July meeting.

Throughout the tightening cycle, the central bank has given the message that it is data-dependent—and Powell confirmed that he and his colleagues will continue to rely on what the data convey.

“This Fed has proven to be both very deliberate and highly data-driven,” Robert Johnson, a professor at Heider College of Business at Creighton University, told The Epoch Times. ”If the data show that inflation is ticking upward, this Fed will not hesitate to pause rate cuts or even to reverse course.”

The annual inflation rate has increased for two consecutive months, touching 2.7 percent. Early estimates suggest next month’s consumer price index will rise to 2.9 percent.

Tom Essaye, founder and president of Sevens Report Research, opined that the number of rate cuts does not really matter for the markets. What truly counts is the direction in which rates are headed, he said.

“It’s not so much the number of rate cuts that matter as much as it is the direction of rates—so as long as they’re still falling, the pace isn’t really that important,” Essaye said in an email to The Epoch Times.

Still, according to Adam Turnquist, chief technical strategist for LPL Financial, uncertainty surrounding monetary policy has returned.

“At a minimum, market expectations have shifted toward a shallower- and slower-than-anticipated rate-cutting cycle,” Turnquist said in a note emailed to The Epoch Times.

This sentiment immediately appeared in the broader market, including Treasurys.

Reading Wall Street Tea Leaves

In December, the benchmark 10-year Treasury yield added about 30 basis points, reaching 4.56 percent.

This continues the upward trend in yields seen over recent months. Since September, the 10-year yield has increased by nearly 1 percent.

Analysts have reached various conclusions as to why the government bond market has trended higher since the Fed cut interest rates for the first time since the onset of the COVID-19 pandemic.

Federal Reserve Chair Jerome Powell appears on a bank of screens on the floor of the New York Stock Exchange, on Nov. 7, 2024. AP Photo/Richard Drew, File

“Ten-year yields jumped 12 basis points on the day and, notably, broke out above the November highs at 4.50 percent,” Turnquist said. “This is technically significant because it checks the box for a higher high, adding to the evidence of a developing uptrend.”

ING strategists have said that a 5 percent yield is a viable target.

The latest monetary policy development has also lifted the greenback.

The U.S. Dollar Index, which tracks the dollar’s value against a weighted group of six currencies, including the euro and Japanese yen, has jumped by more than 1 percent in December, hovering at about 108. This year, the dollar has soared by about 6.5 percent.

The global reserve currency could maintain its strength throughout 2025, according to ING strategists.

“While a stronger dollar is very much a consensus (and our own view) for 2025, today’s bearish flattening of the U.S. curve—telling us the Fed will not be providing as much monetary stimulus as first thought—is a clearly bullish factor for the dollar,” they said in a note.

A higher-for-longer economic climate could deliver a blend of good and bad news for consumers and businesses.

The most notable product that will be affected is mortgages. The 10-year is typically seen as the primary benchmark for the direction of mortgage rates. It is no coincidence that as the 10-year has climbed, the 30-year fixed mortgage rate has followed, trending upward toward 7 percent.

The Fed’s decision to leave interest rates high could be a welcome one for savers and conservative investors. High-yield savings rates and the money markets will continue to generate decent returns.

Regarding the broader market reaction on Dec. 18, Jamie Cox, managing partner at Harris Financial Group, viewed the market decline as an irrational episode.

The blue-chip Dow Jones Industrial Average tanked more than 1,100 points by closing bell on Dec. 18, which had extended its then-losing streak to 10 days, the first time since 1974.

“Markets have a really bad habit of overreacting to Fed policy moves. The Fed didn’t do or say anything that deviated from what the market expected,” Cox said in a note emailed to The Epoch Times.

Traders may have gotten the red ink out of their system, as the stock market rebounded in the subsequent sessions.

The Dow Jones, the tech-heavy Nasdaq Composite Index, and the S&P 500 Index regained much of their losses.

“The good news is that this 10-day sell off should lay the path for a Santa Rally leading into next week,” Cox said.