The Federal Reserve will hold its first policy meeting of the year on January 28 and 29, widely expected to keep interest rates on hold after cutting them three times since September.
The Fed has a dual mandate: First, it aims to maintain inflation, which means keeping inflation at around 2% per year as measured by the Consumer Price Index (CPI). Second, it requires the economy to operate at full employment, even without a formal target for the unemployment rate.
The Fed has bought inflation from 2022, which is why it is lowering the federal funds rate (the overnight interest rate that banks charge) at the end of 2024. It may stay 2% higher than expected. As a result, the Fed recently lowered its forecast for a rate cut in 2025.
Here’s where investors can expect the next drop in prices, and what that could mean. S&P 500(SNPINDEX: ^GSPC) Stock market index.
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The Covid-19 pandemic was a once-in-a-generation event. The US government responded appropriately by injecting trillions of dollars into the economy in 2020 and 2021 to prevent a major recession (or worse). The federation is also reduced Federal funds Close to 0% historic lows and trillions of dollars pumped into the financial system through quantitative easing (QE).
Such a sharp increase in the money supply is bound to cause inflation. But the outbreak has also raised supply chain issues as factories around the world have shut down to curb the spread of the virus, raising prices for many consumer goods. It added to the inflation cocktail, resulting in a 40-year high in CPI of 8% by 2022.
Still, the federation was forced to react quickly. Between March 2022 and August 2023, it raised the federal funds rate by 0.1% to 5.33%. It was one of the fastest increases in history, but thankfully it worked because CPI dropped to 4.1% in 2023, and continued to decline in 2024.
The downward trend was enough for the Fed to cut rates in September, November and December 2024. But after falling to a 2.4% annual rate in September, CPI has now risen for three consecutive months. 2.9% in December
Four times a year — in March, June, September and December — the Fed releases a report called the Summary of Economic Forecasts (SEP). Each member of the Federal Open Market Committee (FOMC) tells the public where they think economic growth, inflation and the federal funds rate will be over the next few years.
Since the FOMC is responsible for setting federal interest rate policy, Wall Street watches each SEP closely. In September SEP, the FOMC forecast five possible interest rate cuts through 2025, but this forecast was reduced to two cuts in December SEP.
The reasons? First, the consensus forecast for 2025 gross domestic product (GDP) growth rose to 2.2 percent in December from 1.8 percent in September. Second, the consensus forecast for personal consumption expenditures (PCE) inflation for 2025 rose from 2.1% to 2.5%.
In other words, FOMC members are pushing for a stronger economy in 2025 than previously expected, accompanied by higher inflation. That means lower interest rates.
Wall Street is more cautious. As of 2011 CME groupFedWatch tool, traders just wait. one The rate is reduced for the whole of 2025. It is predicted to happen in June, which means the Fed will stand still and do nothing for the next five months.
The federation has a very tough job ahead of it. Historically, central banks have had a habit of keeping interest rates high for long periods of time, often leading to economic downturns and recessions:
For this reason, I think Fed Chairman Jerome Powell deserves credit for cutting the federal funds rate three times, even though the CPI is still above the 2% target.
Low prices are good for stocks For a few reasons. They allow companies to borrow more money to accelerate growth while reducing their interest costs. Both of these factors can increase corporate earnings, and earnings will drive stock prices.
In addition, falling prices reduce the yield of risk-free assets such as cash and Treasury securities, pushing investors into growth values such as stocks and pushing forward prices higher.
With that, every bearish cycle since 2000 has been followed by a temporary dip in the S&P 500.
The three cut cycles in the chart above were triggered by significant economic shocks: the bursting of the dot-com Internet bubble in the early 2000s, the 2008 global financial crisis, and the 2020 pandemic. Each instance was because of those adverse events, not because interest rates were falling.
That brings me to my final point: Investors don’t want to see the Fed cut rates because the economy is weak. That coincides with sluggish corporate earnings, which is a recipe for a decline in the S&P 500 even as rates are falling. There is no reason to fear now, but the unemployment rate is higher in 2024 (from 3.7% to 4.1%), which could be a sign of trouble ahead.
If something bad happens and causes a correction in the S&P 500, investors should see it as a long-term buying opportunity. After all, history proves that the index always rises to new highs given enough time.
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