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Why Today (dec. 18) Is A Big Day For The Stock Market
The U.S. stock market is having a banner year. The S&P 500 (SNPINDEX: ^GSPC) has surged 27% in 2024, putting the index on track for one of its best performances of the 21st century. Expectations that the Federal Reserve will cut interest rates several times before the end of 2025 have factored heavily into that upside.
Indeed, the futures market is currently pricing in three quarter-point cuts by December 2025. And some Wall Street analysts are even more optimistic. Goldman Sachs expects three quarter-point cuts by March 2025. And JPMorgan Chase anticipates five quarter-point cuts by December 2025. But those projections may be unrealistic given that inflation has reaccelerated in recent months.
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That's why today (Dec. 18) could be a big day for the stock market. Fed officials will not only announce an interest rate decision at 11:00 AM ET, but also update their long-term economic projections to provide visibility into 2025. If those projections show fewer rate cuts that investors expect, the stock market could tumble.
How the Federal Reserve's stance on monetary policy has changed in recent years
The Federal Reserve is charged with setting monetary policy that promotes stable prices (i.e., steady inflation) and maximum employment. To achieve that goal, officials adjust the target federal funds rate, a benchmark that influences other interest rates across the economy.
High interest rates slow economic growth by creating a disincentive borrowing, which leads to less inflation but more unemployment. Alternatively, low interest rates stimulate economic growth by encouraging people and businesses to spend money, which leads to more inflation but less unemployment.
The timeline below details how the Federal Reserve's stance on monetary policy has changed in recent years:
- March 2021: Inflation as measured by the Consumer Price Index (CPI) crossed above the Federal Reserve's 2% target as Covid-19 disrupted supply chains and the government pumped stimulus into the economy.
- March 2022: The Federal Reserve raised its benchmark rate for the first time since 2018. Many economist argued Fed officials adjusted their monetary policy too slowly.
- June 2022: CPI inflation peaked at 9.1%, the highest reading since 1981. Federal Reserve policymakers responded by pressing forward with the most aggressive rate-hike cycle in four decades.
- July 2023: The Federal Reserve raised the target federal funds rate to 5.25% to 5.5%, the highest level since 2001. While not apparent at the time, that turned out to be the final rate hike in the tightening cycle.
- September 2024: The Federal Reserve lowered the target range by a half-point, marking the first rate cut since 2020. Officials projected three more quarter-point cuts in 2024, and four quarter-point cuts in 2025.
- November 2024: The Federal Reserve cut the federal funds rate by a quarter-point, bringing the target range down to its current level, 4.5% to 4.75%.
Federal Reserve officials last published long-term economic projections at the September meeting, but their forecasts were based on assumptions that have since proven false. They expected GDP to increase 2% this year, but it surged 2.8% in the third quarter. Officials also expected unemployment to hit 4.4% in 2024, but it peaked at 4.3% in July.
Fed Chairman Jerome Powell mentioned those inaccuracies in a recent interview. "The economy is strong, and it's strong than we thought it was going to be in September," he said. "Labor market growth is definitely stronger than we thought and inflation is coming a little higher. So, the good news is we can afford to be a little more cautious as we try to find neutral."
Image source: Getty Images.
Inflation is moving the wrong direction, so the Federal Reserve may revise its long-term projections
Recent inflation numbers make the outcome of the Fed's December meeting even more uncertain. Specifically, after bottoming at 2.4% in September, CPI inflation has increased in two consecutive months, reaching 2.7% in November. That was in line with expectations, but it still means consumer prices are moving in the wrong direction.
Similarly, the Producers Price Index (PPI) for final demand -- which tracks inflation at the producer level rather than the consumer level -- bottomed at 2% in September. But like CPI inflation, the PPI for final demand has since increased in two straight months, reaching 3% in November. That dramatically exceeded expectations.
Here is the bottom line: The futures market is currently pricing in three quarter-point cuts in the federal funds rate before 2025, and some investors undoubtedly expect more. Indeed, the Federal Reserve signaled four quarter-point cuts in 2025 when it last updated its long-term economic projections in September.
However, the economy and labor market are stronger than expected, and inflation is once again increasing. That will almost certainly cause officials to rethink their long-term outlook. The stock market could tumble if the updated projections published today fall short of what investors anticipate. Alternatively, if the Federal Reserve's projections align with or exceed expectations, the stock market could surge.
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JPMorgan Chase is an advertising partner of Motley Fool Money. Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Goldman Sachs Group and JPMorgan Chase. The Motley Fool has a disclosure policy.
