Forget the Stock Market Tumble. The Fed Made the Right Move in a Wild Week

Federal Reserve Chair Jerome Powell played a pivotal role in driving volatility on Wall Street last week. However, a decision by policymakers to pause further interest rate cuts appears to be justified, particularly in light of new inflation data and political uncertainty surrounding the federal budget.

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Steve Blitz, chief U.S. economist at TS Lombard, highlighted that the latest personal income data for November supports the Federal Reserve’s decision to hold off on further cuts. In a note released Friday, Blitz also pointed to the House of Representatives' struggle to pass a spending bill as an additional reason for the Fed’s cautious stance. He remarked that the White House may face significant challenges in securing its agenda in the coming two years, given the current political gridlock.

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The stock market saw dramatic swings midweek after the Federal Reserve implemented a widely anticipated interest rate cut. More notably, the Fed signaled that fewer rate cuts than previously expected are likely in 2025.

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Following this announcement and Powell’s subsequent news conference, the Dow Jones Industrial Average fell over 1,100 points, marking a 10-session losing streak—the longest in 50 years. The S&P 500 experienced its sharpest drop on a Fed decision day since January 2009, falling nearly 3%, while the Nasdaq Composite plunged 3.6%.

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The market’s reaction puzzled some experts. Peter Boockvar, chief investment officer at Bleakley Financial Group, noted that the rates market had already priced in the Fed’s outlook for around two quarter-point cuts in 2025, rather than the previously anticipated four. Boockvar likened investors’ behavior to the children’s book When You Give a Mouse a Cookie, suggesting that the market, initially aligned with the Fed’s projections, quickly scaled back its rate-cut expectations even further.

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Investor skepticism stemmed partly from the Fed’s acknowledgment of persistent inflationary pressures. September and October inflation figures exceeded expectations, challenging the central bank’s projections. Powell candidly admitted during his news conference that inflation forecasts have consistently fallen short as the year-end approaches, underscoring the complexity of the economic landscape.

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This placed significant focus on the November personal consumption expenditures (PCE) index, the Fed’s preferred inflation gauge. While the PCE index typically aligns with economists’ estimates—thanks to prior consumer and producer price data—it holds weight in shaping the Fed’s future policy moves. November’s core PCE reading, which excludes volatile food and energy prices, rose 2.8% year-over-year, matching October’s pace and slightly easing market concerns.

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Following the PCE report, stocks rebounded sharply. Remarks from Federal Reserve officials further fueled optimism. Chicago Fed President Austan Goolsbee expressed confidence that inflation remains on course to reach the Fed’s 2% target. He suggested that interest rates could decline significantly over the next 12 to 18 months, which encouraged buying activity in equities.

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Despite the rebound, major indexes still ended the week with losses. However, Friday’s rally helped the Dow gain nearly 500 points, or 1.2%, while the S&P 500 climbed 1% and the Nasdaq advanced 1.1%.

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Krishna Guha, head of Evercore ISI’s global policy and central bank strategy team, noted that November’s inflation data provided evidence that the Fed’s real-time inflation assessments were accurate. Factors like softening non-housing services and slightly negative goods inflation suggest the overall inflation trajectory remains stable, albeit uneven. Guha stated that further confirmation of this trend in the coming months could pave the way for the Fed to implement rate cuts as early as March, with additional easing potentially signaled for June.

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In the broader economic and political context, Elon Musk, CEO of Tesla Inc., became a surprising figure in budget negotiations. Musk reportedly influenced efforts to derail a bipartisan bill intended to prevent a government shutdown. This added another layer of uncertainty to markets already reeling from the Fed’s final meeting of the year. By Saturday night, lawmakers scrambled to pass a stop-gap funding measure to avert a shutdown, highlighting the contentious nature of federal budget talks.

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Kent Engelke, chief economic strategist at Capitol Securities Management, viewed the budget showdown as a peripheral issue for financial markets. However, he acknowledged it as a precursor to potential battles over funding growing government deficits, an issue that could weigh on investor sentiment in the year ahead.

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Amid these developments, economic data continues to reveal mixed signals. Blitz pointed to a resurgence in inflation across core goods and services (excluding housing and energy) as private-sector employment strengthens. Rolling three-month employment data indicates an uptick in hiring, which has contributed to rising real wages. This, in turn, has bolstered discretionary spending, even as households dip into savings amid lower savings rates.

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Blitz concluded that the Federal Reserve’s decision to pause interest rate adjustments is prudent, given the current economic rebound and uncertainties surrounding fiscal policy. With inflationary pressures leveling off and no clear indications of significant policy shifts to stimulate growth, the Fed is wise to adopt a wait-and-see approach.

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