Federal Reserve policymakers expect to raise their key interest rate to 5.1% next year, higher than what Wall Street is counting on. The new projections, released at the end of Wednesday’s Fed meeting, were unveiled along with the news everyone was expecting: a half-point rate hike. The S&P 500 initially turned lower on the Fed news.
Today’s rise to a range of 4.25% to 4.5% came as the Fed eased the pace of its tightening after four consecutive 75 basis point steps.
The immediate question now is whether policymakers will take another step back at the next Fed meeting. Ahead of today’s Fed announcements, as of February 1, markets had priced in a 60% chance of just a quarter-point increase.
Fed Chair Jerome Powell will have a chance to offer guidance on the size of the next rate hike at his 2:30 p.m. ET press conference.
Fed Meeting Clarifies Rate Rise Outlook
The new set of quarterly projections from Fed policymakers shows that the key overnight interest rate will rise to 5.1% in 2023 and ease to 4.1% in 2024.
Since his August speech in Jackson Hole, Wyo., Chairman Powell has emphasized that the Fed will need to keep interest rates high longer to minimize the risk of a prolonged bout of high inflation, as it did in the 1970s.
Forecasts released after the Sept. 21 meeting had indicated that Federal Funds rates could rise to 4.6% in 2023, before falling to 3.9% in 2024. Powell has subsequently said that the Fed’s peak rate of the cycle, or interest rates, would likely have fallen. rise above 4.6%.
In fact, markets had priced in a final rate of around 5.05% just ahead of Tuesday’s softer-than-expected CPI inflation numbers.
But in the wake of CPI data showing core inflation rising just 0.2% last month, markets anticipated a spike of 4.9% ahead of today’s Fed meeting.
Still, there was good reason to doubt that Fed Chairman Jerome Powell will be swayed by the tamer numbers for the consumer price index and core CPI inflation. Powell even gave a speech on Nov. 30 explaining why these are wrong inflation numbers for the Fed to consider.
S&P 500 near key level
The S&P 500 fell 0.7% in Wednesday’s stock market action following news of the Fed meeting. That reversed Tuesday’s gains of 0.7%, but the S&P 500 was up nearly 3% at Tuesday morning’s highs following the tame CPI. But investors probably didn’t want to be misled by an aggressive Fed meeting.
The Dow Jones Industrial Average fell 0.5% after the Fed meeting, while the Nasdaq composite lost 1%.
The S&P 500 crossed its 200-day line intraday for a second straight day on Wednesday before falling below key technical levels following the policy statement from the Fed meeting. The past several rally attempts through April have stalled on the 200-day moving average.
All major indices met resistance at their peak on December 1 on Tuesday.
Through Tuesday’s closing price, the S&P 500 is up 10% from its October 12 bear market low. Still, the S&P 500 remains 18% below its all-time high on Jan. 3. The Dow Jones is up 16.5% since bottoming, putting it just 9% off its all-time high. The Nasdaq is up 6.6%, but remains 31.5% below its high.
Be sure to read IBD’s The Big Picture column after each trading day to stay up to date on the prevailing stock market trend and what it means for your trading decisions.
The Fed’s new key inflation rate
The specific rate of inflation that Powell says the Fed and Wall Street should focus on comes from the Department of Commerce’s Monthly Report on Personal Income and Expenses, which tracks Personal Consumption Expenditure, or PCE.
Powell’s favorite new inflation rate happens to be the most problematic for the S&P 500. The gauge takes into account commodity inflation, which is falling rapidly. It also excludes housing inflation, which looks set to fall in 2023 as government data catches up with stagnant growth in market rents.
That leaves only core services other than housing, such as health care, education, catering and hairdressers. Because price changes for such services are closely related to wage growth, they give the best signal of where core inflation is headed, Powell said.
The Fed’s new key inflation rate isn’t great for the S&P 500 because it focuses on the strongest part of the economy: the tight labor market. Until the labor market bursts, wage growth is likely to remain stubbornly high and the Fed may raise its benchmark rate higher and for longer than markets expect.
The CPI report showed that prices of core services excluding lodging were flat in November from the previous month. But the comparable PCE index won’t be so tame. That’s partly because the two indices measure healthcare inflation in many different ways, with the PCE measure more reflective of wage pressures. The medical care CPI index fell 0.7% in November, the largest monthly decline ever.
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