On December 18, 2024, at the Federal Reserve meeting, the Fed announced a 25-basis-point cut to its overnight borrowing rate, bringing it to a target range of 4.25% to 4.5%. This decision marks the third consecutive rate reduction, and the Fed is voicing an increasingly cautious approach to future rate cuts.

The Fed noted that inflation has continued to cool, with the latest data showing a 12-month inflation rate of 2.7%, moving closer to the Fed’s 2% target, saying directly, “The labor market has cooled from its formerly overheated state and remains solid. Inflation has moved much closer to our 2% longer-run goal.” The Fed also acknowledged that the economy remains robust, driven by strong consumer spending and a resilient labor market.

At each quarterly meeting, they publish their economic projections, and it’s missed the mark pretty significantly this year. At this meeting, they revised the short-term growth expectations up and longer-term growth expectations down. The inflation expectation was revised up significantly for 2025 from 2.1% to 2.5%. Longer term, there was no meaningful revision in inflation.

The reaction in stock markets was negative, likely due to a few factors. First was the Fed’s indication that it anticipates only two more rate cuts in 2025, a reduction from the four cuts previously projected. Investors are adjusting their expectations for less accommodative policy. Second was the increase in their 2025 inflation target, hand in hand with fewer 2025 cuts. Finally, and underappreciated, is the removal of some of the “forward guidance” of a lower neutral rate.

In bond markets, Treasury yields rose following the Fed’s announcement. Higher yields reflect the market’s adjustment to the Fed’s more hawkish tone and the expectation of fewer rate cuts in the near future. This shift can lead to higher borrowing costs and may impact bond prices negatively in the short term.

While the Fed’s decision aims to balance economic growth and inflation, it also signals a more measured approach to future rate cuts. The reduced future potential accommodation from the Fed is a negative signal for the markets, and after a rate-hiking cycle that was sharp, we’ll be watchful of the impact on credit markets, in particular. Often a negative impact in credit markets is the canary in the risk coal mine that can lead to further negative impacts on equity markets.