Despite Bearish Reaction to Fed Cuts, Economy Poised for Growth

In a move that had been broadly anticipated, the Fed's Federal Open Market Committee (FOMC) cut its target range for the overnight fed funds rate to 4.25% to 4.5%, which was down 25 basis points from where it had been. This took the fed funds rate down 100 basis points from where it had peaked (5.25% to 5.5%) post-pandemic and remained through September when the committee implemented a panicky 50 basis point cut. 

Anticipated? Almost as soon as the policy statement and economic projections were released, equities sold off as did treasury debt securities. This pushed yields higher as the U.S. Dollar Index popped and gold, silver and Bitcoin moved toward their session lows. This is that story.

The Policy Statement

There really is not much to say here. This was a total cut-and-paste job. I guess the Fed has absolutely no use whatsoever for an economics writer. This crew changes a word or two here or there and calls it a day. I see only two minor changes in the statement. They are both in the third paragraph. After re-assuring readers that unemployment remains low and inflation somewhat stubborn, this statement announces that the quarter percentage point rate cut in exactly the same way as in November, with the exception that the new target range is 4.25% to 4.5%. 

In the very next sentence, the words "the extent and timing" are inserted into an existing sentence that now reads, "In considering the extent and timing of additional adjustments to the target range for the federal funds rate, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks." 

Guess they want to make sure that we know how careful they are. Jeez.

Quarterly Economic Projections

Here is what hurt the market as soon as it was released: As far as year-end 2024 GDP is concerned, the FOMC's median expectation moved all the way up to growth of 2.5% from just 2% in September. In taking the committee's expectations for economic growth significantly higher, the committee also took their year-end median expectation for the unemployment rate down to 4.2% from 4.4% in September, while taking PCE inflation up to 2.4% from 2.3%, and Core PCE up to 2.8% from 2.6%.

Basically, the Fed now sees more economic activity, increased inflation and less unemployment than they as a group had anticipated just three months ago. After considering all of that, the FOMC left their year-end projection for the fed funds rate at 4.4%, where it had been in February and where they essentially took that target (4.25% to 4.5%) for that rate today.

None of that really took financial markets by surprise. What did hit financial markets on Wednesday afternoon was the FOMC's median projection for the fed funds rate at year's end 2025, in 12 months. The FOMC took that expectation up to 3.9% from 3.4%. To put it bluntly, the FOMC cut their 2025 expectations from four 25 basis-point rate cuts down to just two 25 basis-point rate cuts.

While the FOMC was taking their 2025 interest rate projections higher, they also took their projections for 2025 PCE higher — 2.1% to 2.5% at the headline level and 2.2% to 2.5% at the core. Unemployment for 2025 was taken slightly lower while FDP for 2025 was taken slightly higher. The fact is that the Fed is likely thinking that they can no longer continue for very long to ignore the inflation side of their dual mandate as inflation has clearly reaccelerated into year's end 2024.

Additionally, and probably much to the chagrin of many equity investors, the FOMC also took the group's median projections for the fed funds rate at year's end 2026, 2027 and for the longer run higher, suggesting that at no time the perceived loss of two rate cuts in 2025 will be made up at a later date.

The Press Conference

Fed Chair Jerome Powell did not appear to be in a dovish mood on Wednesday afternoon. During his address and Q&A session, Powell made clear that the FOMC can be more cautious going forward. He actually commented that the "extent and timing" language in the statement that I mentioned above was there because the Fed may be at or near the point of slowing down on interest rate cuts. He also referred to the increased rate of inflation over recent months as what is behind this caution, saying that inflation was "probably the biggest factor" for the changes made to the committee's economic projections.

My Thoughts

Though my net long P/L took a bit of a hit while I was writing up this piece, I am heartened that the Fed plans to tackle inflation as it had looked like maybe they had gone mad and had eased policy from September into year's end. Being two months ahead of the election and aggressive at the start, were those moves political in nature?

I had made that argument at the time and been rebuked by some very intelligent people who I have great respect for. That said, the election is over, and the transition of power is set for just about a month from now. It is odd that there was no apparent reason for the rate cuts this autumn and now that there is to be a transition in power, sanity and religion in regard to the use of policy to fight inflation are cool again. I don't know if that bit of dovishness was political, but it sure does force one to ask the question. Again.

As for markets, higher short-term rates next year have to be priced back in. That might hurt a little, but we do have to remain vigilant on inflation and there is the promise of an easier regulatory environment and maybe even lower personal and corporate taxes going forward. That can propel the economy and our markets, so this is in no way a final score.

Oh, it was also nice to see Beth Hammack, the new Cleveland Fed president, dissent from the decision to cut rates today in favor of holding steady. I don't know much about Hammack, but that took guts being how new she is. I like that. Score one for team hawk.

At the time of publication, Guilfoyle had no positions in any securities mentioned.