The US Federal Reserve bank held interest rates steady on Wednesday night and paved the way for potential cuts in 2024.
ADVERTISEMENTThe Fed decided to keep interest rates unchanged, maintaining the range between 5.25% and 5.5% in its last meeting of the year. This decision marked the third consecutive meeting of unchanged rates, signaling the likely end of the tightening cycle initiated in March 2022.
While the rate decision itself was highly anticipated by financial markets, it was the Fed's forward-looking outlook that generated the most significant reactions.
The updated Summary of Economic Projections suggested a notable shift in the Fed’s policy towards a more accommodative stance. The new ‘dot plot’ effectively eliminated any further hints of rate hikes and revealed a median preference for the fed funds rate to fall to 4.6% by the end of 2024, implying a potential 75 basis points of rate cuts.
To put this into perspective, back in September, the Fed had projected rates to only decline to 5.1% at the end of 2024, making the new outlook decidedly more "dovish." The Fed envisioned interest rates dropping further to 3.6% in 2025 and 2.9% in 2026.
In terms of economic growth, Fed officials revised their GDP growth estimates upward for the current year. However, they foresaw a slowdown in 2024, with the median forecast easing to 1.4%. The December policy statement also cautioned that "growth of economic activity slowed from its strong pace in the third quarter."
On the positive side, the inflation outlook showed signs of improvement. The Personal Consumption Expenditure (PCE) price index, the Fed's favored inflation gauge, was expected to decline to 2.4% in 2024 and to 2.1% in 2025, eventually reaching the 2% target in 2026. Excluding energy and food prices, the inflation gauge was set to exhibit a similar trend. Both of these estimates were modestly lowered from the September projections, indicating a stronger conviction in the ongoing disinflationary trend.
Powell sticks to dovish tones, markets rally
During his press conference, Fed Chair Powell stated that interest rates were "likely at or near the peak of this tightening cycle" and that the restrictive monetary policy stance was exerting "downward pressure on economic activity and inflation." Powell acknowledged that rate reductions were now being discussed within the Fed.
“There was a general expectation that rate cuts will be a topic of conversation going forward,” the Fed Chair stated.
Powell continued to envision a historically unusual economic trajectory in which inflation eased without the need for a rise in the unemployment rate, with economic growth facing limited adverse effects.
Nonetheless, Powell dampened the enthusiasm surrounding the inflation path by emphasising that the achievement of the 2% target was a gradual process without assured success, firmly stating that declaring victory at this point was still premature.
In response to the Fed's decision and Powell's remarks, market sentiment sharply improved with investors flocking to risky assets. Stocks and bonds rallied, while the US dollar experienced a decline.
Market expectations for Fed rate cuts further surged following the Fed meeting. Based on money market pricing, speculators are increasingly factoring in the likelihood of rate cuts beginning as early as March 2023, anticipating as many as six rate cuts in the upcoming year.
Yields on a 2-year Treasury note fell by 30 basis points to 4.43%, the lowest since early June.
The Dow Jones Industrial Average surged to fresh all-time highs, closing above 37,000 points, surpassing previous peaks reached in early January 2022. The S&P 500 and the Nasdaq 100 remained within a mere 2% and 1% of their respective record highs.
Additionally, the euro-dollar exchange rate spiked above 1.09 overnight, and gold prices rose back above $2,020 per ounce.
Markets are now awaiting interest rate decisions from the Bank of England and the European Central Bank, set to be announced at 13:00 and 14:15 CET, respectively.
