Federal Reserve policymakers expect to raise their key interest rate to 5.1% next year, higher than Wall Street had expected. The new forecasts, released at the end of the Fed’s meeting on Wednesday, were revealed alongside an expected half-point rate hike. The S&P 500 initially fell sharply. Stocks edged lower but failed to sustain gains after Fed Chair Jerome Powell did not rule out another rate hike of up to a quarter point.


Today’s rise to a range of 4.25% to 4.5% came after the Fed reduced the pace of its tightening after four straight 75-point moves.

Ahead of today’s Fed announcement, markets were pricing in a 60% chance of just a quarter point rise on February 1st. That fell to about 47% immediately after the Fed announcement, but rebounded to 60% due to Powell’s comments.

The Fed chairman downplayed the importance of the size of the next hike, saying what matters is how high interest rates are and how long they stay high. But he said it was too early to tell whether the next move would be 50 basis points or 25 basis points, and Powell reiterated several times that inflation risks remain weighted to the upside.

But the pace is important to investors because it gives more time for further soft inflation readings or weaker employment data to convince the Fed to hold off on raising interest rates until they pass 5%.

Powell added that he wants to see “substantially more evidence” that inflation is under control. But he noted that “our policy is taking quite a good position”.

Fed meeting clarifies rate hike outlook

A new batch of quarterly forecasts from Fed policymakers shows the key overnight lending rate rising to 5.1% in 2023 and easing to 4.1% in 2024.

The Fed now expects the unemployment rate to rise to 4.6% next year as growth slows to 0.5%.

Since his August speech in Jackson Hole, Wyo., Chairman Powell has stressed that the Fed needs to keep interest rates on hold for longer to minimize the risk of a protracted bout with high inflation like in the 1970s.

Forecasts released after the Sept. 21 meeting suggested the federal funds rate could rise to 4.6% in 2023 before easing to 3.9% in 2024. Powell went on to say that the Fed’s cycle peak, or final rate hike, would likely be: up from 4.6%.

In fact, markets were pricing in a terminal rate of around 5.05% just ahead of Tuesday’s softer-than-expected CPI inflation data.

But on the heels of CPI data showing core inflation rose just 0.2% last month, markets priced in a 4.9% peak rate ahead of today’s Fed meeting.

However, there was good reason to doubt that Powell would be swayed by the tamer readings of consumer price index and core CPI inflation. In fact, Powell gave a speech on November 30 explaining why these are the wrong inflation rates for the Fed to consider.

S&P 500 Near Pivotal Level

The S&P 500 fell 0.6% in mixed stock market action following news of the Fed meeting and Powell’s comments. That reversed Tuesday’s 0.7% gain, which eased after the S&P 500 rose nearly 3% to Tuesday morning’s highs following subdued CPI.

The Dow Jones Industrial Average fell 0.4% after the Fed meeting, and the Nasdaq composite lost 0.7%.

The S&P 500 breached its 200-day line for the second day in a row on Wednesday before slipping below a key technical level after the Fed’s policy announcement. The last few rally attempts have stalled at the 200-day moving average back in April.

All major indexes hit resistance at December 1 highs on Tuesday.

At Tuesday’s close, the S&P 500 was up 10% from its lows at the close of the Oct. 12 bear market. However, the S&P 500 remains 18% below its record high of Jan. 3. The Dow Jones rallied 16.5% after falling 16.5%, leaving it just 9% from its all-time high. The Nasdaq jumped 6.6% but remains 31.5% off its peak.

Be sure to read IBD’s “Big Picture” column after each trading day to get the latest prevailing stock market trend and what it means for your trading decisions.

The US economy is in for a hard landing until the Federal Reserve does

The Fed’s new core inflation rate

The specific inflation rate that Powell said the Fed and Wall Street should be focusing on comes from the Commerce Department’s monthly Personal Income and Expenditure report, which tracks personal consumption expenditures, or PCE.

Powell’s favorite new inflation measure is the most problematic for the S&P 500. The gauge affects commodity inflation, which is falling rapidly. It also excludes housing inflation, which looks set to ease in 2023 as government data catches up with slower growth in market rents.

Apart from that, only basic services such as health care, education, hospitality and hairdressing remain from the apartment. Because price changes for such services are closely tied to wage growth, they provide the best signal of where core inflation is headed, Powell said.

The Fed’s new core inflation gauge is not good for the S&P 500 because it focuses on the strongest part of the economy: the labor market. Until the labor market cracks, wage growth is likely to remain stubbornly high, and the Fed could raise its benchmark interest rate higher and longer than markets expect.

The CPI report showed that prices for basic services, excluding accommodation, were unchanged in November from the previous month. But a similar PCE index won’t be as soft. That’s partly because the two indexes measure health care inflation in very different ways, with the PCE measure more reflective of wage pressures. The CPI index for medical care services fell 0.7% in November, its worst monthly decline ever.


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