Market Reality Check: Fed’s Cautionary Outlook Sparks Sell-Off
The recent interest rate cut by the Federal Reserve, accompanied by a revised outlook on future rate cuts, has given investors a much-needed reality check, according to Jeremy Siegel, professor emeritus of finance at the University of Pennsylvania’s Wharton School. The Fed’s decision to lower interest rates by a quarter percentage point, bringing the overnight borrowing rate to a target range of 4.25% to 4.5%, was met with a sell-off on Wall Street, as investors had been betting on more aggressive rate cuts.
A Pause in Monetary Policy
The Federal Open Market Committee’s revised forecast, indicating only two more rate cuts in 2025, has sparked a shift in market sentiment. Siegel believes the market was overly optimistic about the prospect of low interest rates and is now adjusting to the new reality. The Fed’s cautionary outlook has also led to a reevaluation of inflation expectations, with the personal consumption expenditures price index expected to remain elevated at 2.5% through 2025.
Inflation Concerns and Tariff Impacts
The Fed’s inflation forecast has been influenced by potential tariffs, which could have a significant impact on the economy. However, Siegel suggests that the actual tariffs may not be as severe as feared, as President-elect Donald Trump would likely aim to avoid market pushback. Meanwhile, market participants are now pricing in a 43.7% chance of a 25 basis-points rate cut at the Fed’s June gathering.
Economic Strength and Monetary Policy
Despite high short-term interest rates, the economy has remained strong, catching the Fed off guard. This has led to a new phase of monetary policy, with the Fed entering a pause phase, according to Jack McIntyre, portfolio manager at Brandywine Global. As the Fed balances inflation concerns with economic growth, market volatility is likely to increase in 2025.
What’s Next for Interest Rates?
Marc Giannoni, Barclays chief U.S. economist, maintains that the Fed will cut rates twice in 2025, in March and June, before resuming incremental rate cuts around mid-2026. However, Siegel suggests that there is also a chance of no rate cut next year, given the Fed’s revised inflation forecast. As the market adjusts to the new reality, one thing is clear: interest rates will continue to play a crucial role in shaping the economy in 2025.
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