Wall Street has been bracing for a hawkish Federal Reserve meeting outcome tomorrow, but maybe not hawkish enough. A third rate cut still looks like a virtual certainty, but markets haven’t yet grasped that it may well be the last one. Investors should be prepared for an S&P 500 letdown, if that’s the gist of Wednesday’s new batch of Fed interest-rate projections and Chairman Jerome Powell’s news conference.
But don’t fret. Three rate cuts and done worked for the S&P 500 in 2019, as well as in 1995-96, with the latter being a precursor to then-Fed Chairman Alan Greenspan’s “irrational exuberance” speech in December 1996. Greenspan feared — several years early, it turned out — that the bull market was getting carried away.
↑
X
This Is How A New President Will Impact Fed Rate Cuts In 2025
The Case For A Long Fed Pause
At the moment, markets see slim odds of a further rate cut at the Jan. 29 Fed meeting, but odds tilt to a cut at the March 19 meeting, 58% to 42%, according to CME Group’s FedWatch tool.
However, a good case has emerged for the Federal Reserve to go on an extended pause, potentially holding rates steady for all of next year.
The U.S. economy has grown at a very solid 2.7% pace over the past four quarters, which isn’t suggestive of monetary policy being much too tight. The Fed’s primary measure of core inflation, after dipping to 2.6% in June, has firmed up to 2.8%, well above the Fed’s 2% target.
A surging S&P 500, up 27% this year, is part of the reason why various market-based measures of financial conditions show they are easier than they’ve been since 2021, when the Fed’s key interest rate was still set near zero.
Now, measures of business and consumer confidence are rising amid Fed rate cuts and anticipation of tax cuts and deregulation under President-elect Donald Trump. Given elevated inflation, the financial windfall from a surging bull market, and indications that the economy is on firm footing, the Fed has plenty of reason to stand pat.
Hawkish Fed Rate Cut Due As Market Slides
Neutral Fed Interest Rate
As Powell has explained, the Fed is essentially taking its foot of the brake by lowering the federal funds rate to a neutral interest rate that no longer restricts growth, but doesn’t provide any additional growth impetus either.
Before the Fed cut by 50 basis points in September and an additional 25 basis points in November, Powell could say pretty confidently that the neutral rate was definitely lower than the current policy setting. But after November’s cut, he wasn’t quite as confident.
“We’re pretty sure it’s below where we are now,” Powell said. “But as we move further, there will be more uncertainty about where that is.”
After one more quarter-point move tomorrow, it follows that the Federal Reserve will begin to exercise care that it doesn’t go past neutral.
Deutsche Bank economists made the case last week that a cut tomorrow puts the Fed right at neutral. If the neutral real rate, referred to by economists as “r-star,” is 1.75% — “which we find plausible” — and inflation is running around 2.5%, the neutral rate is 4.3%.
After tomorrow’s cut, to a range of 4.25% to 4.5%, that’s where the Fed will be. Matthew Raskin, head of U.S. rates research at Deutsche Bank, suggested that the Fed stay just above neutral, eschewing a cut on Wednesday, to lower the risk of needing to reverse rate cuts to stem inflation.
1996 Redux For the S&P 500?
Between July 1995 and January 1996, the Fed cut 75 basis points, still leaving its key rate at 5.25%. However, that proved little impediment to financial markets. The S&P 500 rose 20% in the year following that first rate cut, as the dot-com-fueled 1990s bull market kicked into high gear.
“Right now, 2025 looks most analogous to 1996,” Jason Draho, head of asset allocation for UBS Global Wealth Management in the Americas, wrote in a blog post this week.
Like the dot-com era, he’s anticipating a “multiyear productivity surge” from advances in artificial intelligence that propel the economy without boosting inflation. Yet Draho expects some speed bumps in 2025, noting that “many of President-elect Trump’s policies (tariffs, tax cuts, reduced immigration) have an inflationary bias.”
Be sure to read IBD’s The Big Picture column after each trading day to get the latest on the prevailing stock market trend and what it means for your trading decisions.
YOU MIGHT ALSO LIKE:
Join IBD Live Each Morning For Stock Tips Before The Open
These Are The Best 5 Stocks To Buy And Watch Now
IBD Digital: Unlock IBD’s Premium Stock Lists, Tools And Analysis Today
How To Make Money In Stocks In 3 Simple Steps
AI News: Artificial Intelligence Trends and Top AI Stocks To Watch
