After nearly a whole year of triggering a frenzied rebound in the financial markets, Federal Reserve Chairman Powell took the opposite approach on Wednesday, clearly stating a cautious view on rate cuts in 2025, leaving investors astonished.
U.S. stocks collectively plunged about 3%, and U.S. Treasuries also fell sharply, pushing the benchmark 10-year Treasury yield to its highest point in seven months.
About 90 minutes after the Federal Reserve announced its third consecutive rate cut, the market's drop at the end of Powell's speech was the worst since the outbreak of the COVID-19 pandemic, and the message conveyed was very clear: the soaring rise of risk assets over the past two years was suddenly in jeopardy.
This turbulence proves how much confidence the market originally had that the continuous easing policies would boost asset prices. Now, as officials predict only two rate cuts in the next 12 months, these hopes have almost all been dashed, and investors can only pick up the pieces and contemplate their next steps.
"The market was not prepared for this statement from the Federal Reserve," said Tom di Galoma, head of fixed income at Curvature Securities. "Powell is turning neutral, waiting for the next administration to push their agenda, and then seeing what he might need to do."
Of course, Powell's remarks at Wednesday's press conference regarding the 'new phase' of monetary policy were not entirely unfounded. Economic data has consistently suggested that the U.S. economy is vibrant, while inflation remains stubbornly above the Federal Reserve's 2% target. In the $29 trillion U.S. bond market, traders have pushed up the yield on 10-year Treasuries by about 75 basis points since the Federal Reserve first began cutting rates in mid-September. But even they were caught off guard by officials seemingly nearing the end of the rate-cutting cycle.
The swap market currently suggests a rate cut of less than two 25 basis points for the entire year of 2025, even lower than the Federal Reserve's so-called 'dot plot' indications from Wednesday. In the options market linked to the secured overnight financing rate, a large transaction made on Wednesday afternoon local time even hopes to benefit from a new round of interest rate hikes starting next year.
Chris Ahrens, a strategist at Stifel Nicolaus & Co., said: "It sounds like the Federal Reserve will take a very conservative path forward. It turns out that inflation is more resilient than they had imagined, and the upcoming political dynamics add difficulty to near-term forecasting."
Of course, both the Federal Reserve and the market outlook must have a certain degree of flexibility.
President-elect Trump will return to the White House in just over a month, vowing to raise tariffs on major U.S. trading partners and cut taxes, policies that economists believe could stimulate inflation.
Tom Graff, head of investments at Facet Wealth, which manages about $1.5 billion, said: "The threshold for more rate cuts may be much higher than some people expect. The Federal Reserve needs time to regain confidence that inflation is indeed declining, while President Trump's policies will add uncertainty to inflation."
Powell Turns 2.0
In other markets, the Bloomberg Dollar Spot Index soared to its highest level since 2022, while the euro, pound, and Swiss franc all plunged by at least 1%. The offshore yuan also fell to its lowest level since 2023. Due to the Federal Reserve's rate cuts earlier this year and bullish speculation that Trump would stimulate economic growth, Wall Street's most risky sectors were also impacted. Goldman Sachs' 'most shorted' stock index fell by 4.9%, marking the largest single-day decline since February this year, while a basket tracking unprofitable tech stocks dropped by 6.4%, the largest single-day drop in two years. Tesla fell by 8.3%, while Bitcoin, which was approaching a high of $108,000, dropped by 5%.
The S&P 500 index recorded its worst 'Fed Day' performance since March 2020.
Kevin Gordon, the senior investment strategist at Charles Schwab, said: "Typically, when you see market sentiment very jittery, a negative catalyst is needed to overturn the market, and that is the hawkish tone. When market sentiment becomes tense, the speculative little groups in the market are at the 'crime scene', so it is not surprising to see them suffering losses."
Volatility is surging, with the Cboe VIX index soaring above 28, the highest level since the turbulence in August. The cost of options protection for the S&P 500 index has skyrocketed. The volume of VIX call options has outpaced put options by a ratio of 2:1, and the VVIX (which measures the implied volatility of VIX options) has also reached its highest point since early August.
Bank stocks also experienced a sharp decline. The KBW Bank Index fell by 4.3%, with all six major banks on Wall Street, including JPMorgan and Goldman Sachs, each dropping by at least 3%.
Jamie Cox, managing partner at Harris Financial Group, said: "Before this meeting, the stock market had already overheated, which is a good way to get some people to exit before the holidays. Stock prices are high, especially tech stocks, so people will quickly sell off and lock in profits before the holidays. The rate decision was just a catalyst for people to do what they were going to do anyway - sell early and fulfill their wishes after a stellar year in the stock market."
Michael O'Rourke, chief market strategist at Jonestrading, stated that the entire U.S. Treasury yield curve is rising. Both the 2-year and 10-year Treasury yields have experienced this. The surge in yields puts greater pressure on risk assets. "Of course, we are not factoring in concerns over a more hawkish interest rate outlook, yet the market has been on a strong upward trend. This indicates that before the end of the year, we have reason to take some chips off the table. This is a reason for profit-taking. In the short term, the companies that have risen the most will feel the most pain."
Chris Zaccarelli, chief investment officer at Northlight Asset Management, stated that the Federal Reserve is trying to give the market what it wants, but this gift is not welcomed. The market is forward-looking, ignoring today's 25 basis point rate cut and instead focusing on the fact that there will be no rate cuts next year. Predictions show only two rate cuts, which is far below market expectations, and clearly, investors are not satisfied with the future interest rate outlook.
Article forwarded from: Jinshi Data
