The Federal Reserve and its chair, Jerome Powell, made it clear Wednesday that they will move slowly and carefully when it comes to future interest rates, prompting a major sell-off on Wall Street. Investors, though, shouldn't get too nervous, as the central bank is merely responding to a strong economy and the elevated inflation that comes with it, according to DataTrek Research co-founder Nicholas Colas.
"Equity markets were clearly disappointed by Powell's comments, but nothing he said fundamentally alters the bull case going into next year," Colas said in his daily market note Wednesday evening. "In the end, we may see fewer (or even no) rate cuts, but that's because the US economy continues to grow and create marginal inflation as a byproduct."
However, markets took Powell's comments, and Fed officials' adjustments to their outlook for the year ahead, as a more hawkish central bank seeing upside risks to inflation. In the "dot plot" matrix of projections, Federal Open Market Committee meeting participants reduced their expected rate cuts next year to two from four. That it was accompanied by a strongly telegraphed quarter-point reduction in the federal funds rate to a target range of 4.25%-4.5% didn't matter. Markets also adjusted, with fed funds futures contracts now implying virtually no probability of a cut at the January meeting and a roughly even chance of as few as one quarter-point reduction for the full year in 2025, according to the CME Group's FedWatch gauge.
Powell said he supported the Fed's aggressive rate reductions since September, which saw a highly unusual half-point cut, but said the path from here is changing. "We've reduced our policy rate by a hundred basis points. We're significantly closer to neutral. We still think where we are is meaningfully restrictive," the chair said at his postmeeting news conference. "I think from this point forward, you know, it's appropriate to move cautiously and look for progress on inflation."
The Fed will get a look at its preferred inflation indicator Friday when the Commerce Department releases the personal consumption expenditures price index for November. Powell indicated that the reading still will show the 12-month inflation rate above the Fed's 2% goal -- he estimated 2.5% for headline and 2.8% for core -- but the monthly move will be "much lower" than in previous months.
Despite the mixed signals on inflation and rates, Colas thinks investors should still be confident that financial markets will hold up. After a 1,100-point sell-off in the Dow Jones Industrial Average on Wednesday, markets clawed back some of the losses in Thursday's session. "The US economy is in good shape despite still-high policy rates," he said. "In short, the Fed can afford to wait and rule nothing in or out. We think that's fine and remain bullish."