The Fed sparks a market rally as it signals an interest rate cut in 2024

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Wall Street’s benchmark index hit its highest levels in nearly two years after Federal Reserve Chairman Jay Powell sent his clearest signal that the US central bank will start cutting interest rates in 2024 and investors celebrated the prospect of lower borrowing costs.

The Fed kept interest rates at their highest level in 22 years, but the decision came alongside new forecasts from central bank officials pointing to 75 basis points of cuts next year — a more pessimistic outlook for interest rates than previously forecast.

Powell’s comments after the Fed’s decision also signaled a change in the bank’s tone. The benchmark interest rate is now “likely to be at or near its peak during this tightening cycle,” he said.

The Federal Open Market Committee’s decision to keep interest rates at 5.25 percent to 5.5 percent coincided with the publication of the Fed’s so-called dot chart, which showed that most officials expect interest rates to end next year at 4.5 percent to 4.75 percent. . .

Officials expect interest rates to fall even lower in 2025, with most officials expecting them to eventually reach between 3.5 percent and 3.75 percent.

These expectations of a sharper pace of interest rate cuts sparked a rally in US stocks and a sharp decline in Treasury yields, with the two-year yield recording its biggest daily decline since the collapse of the Silicon Valley bank in March.

The two-year Treasury yield, which moves with interest rate expectations, fell 0.3 percentage point to 4.43 percent after the Fed’s announcement. The yield on the 10-year Treasury note fell by 0.17 percentage points on Wednesday, and fell further during morning trade in Asia to remain below 4 percent for the first time since August.

The S&P 500 rose 1.4 percent to close at its highest level since January 2022.

European stocks and government bonds joined the rise on Thursday morning. The regional Stoxx Europe 600 index rose 1.5 percent, driven by a rise in interest rate-sensitive real estate stocks. France’s CAC 40 rose 1.5 percent, while London’s FTSE 100 rose 1.7 percent.

Yields on German 10-year bonds – the benchmark for the euro zone – fell by 0.12 percentage point to 2.04 percent.

“They went from rising for a longer period in September to talking about interest rate cuts,” said Priya Misra, portfolio manager at JPMorgan Asset Management. “They were behind the inflation curve, but perhaps they want to be ahead of the deceleration.”

In a statement, the Fed clarified the terms under which it would consider “any additional policy stabilization that may be appropriate to return inflation to 2 percent over time” — softer language that suggests the central bank may not see a further need to increase inflation. rates again.

Powell reiterated that the central bank is committed to proceeding “carefully” with future interest rate decisions given expectations that economic growth will slow and that there has been “real progress” in beating inflation.

He made that point by saying that the Fed doesn’t want to constrain the economy for longer than necessary.

“We recognize the risk that we may be holding on for too long,” Powell said, referring to waiting too long to cut interest rates. “We know this is a risk and we are very focused on not making this mistake.”

He later added that the Fed would not wait until inflation returns to 2 percent to start cutting interest rates because “you will want to reduce restrictions on the economy long before ‘that point’ so as not to exceed the target.”

The latest decision comes as the Federal Reserve tries to keep monetary policy tight enough to push inflation down to its 2 percent target without hurting the economy and causing too many job losses.

Some traders in the futures markets had expected the Fed to start cutting borrowing costs as early as March, although inflation data this week and a strong jobs report on Friday fueled further bets that the cuts will begin in May. In the run-up to Wednesday’s interest rate announcement, traders bet that interest rates could fall by more than a percentage point next year.

Fed officials’ unemployment forecast has barely changed since September, with officials still expecting the unemployment rate to rise only slightly to 4.1 percent in 2024, from 3.7 percent now.

However, estimates of core inflation, as measured by the personal consumption expenditures index, fell slightly, with officials forecasting it to reach 2.4 percent in 2024 and 2.2 percent in 2025. In September, the median forecast showed inflation at 2.6 percent. In 2025. 2024 and 2.3 percent the following year.

To consider rate cuts, the Fed needs to be confident that inflation is heading back to 2 percent in a sustainable way. If the slowdown in consumer price growth is accompanied by a sharp rise in unemployment, the rationale behind the reduction will be clear.

The looming question is what happens if the economy holds up as inflation declines. Some officials such as John Williams, President of the Federal Reserve Bank of New York, and Christopher Waller, Governor of the Federal Reserve, have suggested that easing monetary policy may still be necessary so that interest rates, once adjusted for inflation, do not become too restrictive for households and businesses. .

Additional reporting by Kate Duguid in New York and Stephanie Stacey in London