What Does the Latest Fed Rate Cut Mean for Markets?

The Federal Open Market Committee (FOMC) met this week and voted to cut rates 0.25 percent, bringing its policy range to 4.25 percent–4.5 percent. This leaves us with 1 percent of cumulative rate cuts in 2024, a notable loosening of monetary policy from where we were at the end of summer. Consensus expectations largely priced in this cut before the meeting, yet markets sold off sharply after the announcement. Let’s look at what contributed to the Federal Reserve’s (Fed’s) decision to cut rates in December, why markets initially reacted so negatively, and which opportunities to focus on in 2025.

Balance of Risks

The Fed’s dual mandate focuses on supporting the stability of consumer prices and maximum employment. On the consumer price side, the latest data shows that though the longer-term trend of cooling inflation remains intact, progress has been slower than the central bank had hoped. The cost of shelter is the largest contributor to the Consumer Price Index, and while there are indications that the price of rent and housing will continue to slow, the path of that deceleration is uncertain and stubborn. Taken by itself, the state of inflation may not have warranted a cut at the December meeting, but it only accounts for one-half of the Fed’s dual mandate.

On the employment side, the labor market remains relatively strong but is showing signs of softening. Although the unemployment rate has ticked up to 4.2 percent and is deteriorating in a directional sense, it is still historically low and represents a healthy employment picture. Employment is not in an alarming position currently, but the softening of the labor market is certainly something Fed officials wish to keep under control, so it could justify the rate cut if taken by itself.

So, how do we interpret two competing mandates that could be pointing us in different directions from an interest rate standpoint? As Fed Chair Jerome Powell expressed at his post-meeting news conference, the current stance is that the risks to both sides of the dual mandate appear to be in relatively good balance. This means the Fed is carefully monitoring both sides of the equation, but neither requires more attention than the other. With that in mind, it’s important to acknowledge that even though the Fed has implemented multiple rate cuts in recent periods, it’s believed current interest rates remain high enough to continue the fight against inflation.

This meeting also came with the release of the FOMC’s updated dot plot of committee members’ expectations for interest rates. Notably, the median committee member now expects only two rate cuts in 2025, down from the four that were expected in the September dot plot.

Focus on Longer-Term Fundamentals

This hawkish recalibration initially frightened markets and led to a sharp sell-off in the hours following the news. Lower rates are generally supportive of equity prices, so the decrease in expected rate cuts was seen as a sign of lesser support going forward. Ultimately, markets trade on fundamentals and, as seen with recently revised third-quarter GDP data, the economy remains strong. This should ultimately lead to solid earnings growth from corporate America. Therefore, investors should focus on the opportunities that volatility creates. This has been a strong year for equity investors, and though weakness always feels bad, a pause isn’t necessarily a negative for the market over the long term.

As we approach the end of the year, analyst consensus estimates for the S&P 500 anticipate that earnings growth will increase 9 percent for 2024. Expectations are for a robust growth rate of 15 percent in 2025. Digging a little deeper into next year, not all earnings growth will come from the biggest companies in the S&P 500 (i.e., the so-called Magnificent Seven), as has been true the past several years. Instead, more companies across industries will see positive earnings growth as the year progresses, as shown in the following chart.

With more companies exhibiting earnings growth next year, there could be more ways to add value to portfolios as more parts of the market show a solid combination of valuations and fundamentals, which should be supportive for equity markets.

Keep on Keeping On

Every year has unique risks, and 2025 looks to be no different. Despite the challenges presented by the uncertainty around Fed policy and the priorities that a new administration in Washington will implement, strong business fundamentals are a reason for optimism. The current environment is certainly dynamic, and one that could create opportunities—even if they aren’t always easy to find among the doom-and-gloom headlines. Remain flexible, keep your long-term goals in focus, and consider using volatility to your advantage to achieve them.

Certain sections of this commentary contain forward-looking statements that are based on reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. This communication should not be construed as investment advice, nor as a solicitation or recommendation to buy or sell any security or investment product. Opinions are subject to change without notice.

What Does the Latest Fed Rate Cut Mean for Markets?