The S&P fell 3% on Wednesday after the Federal Reserve’s policy statement was released where the Federal Open Market Committee (FOMC) dropped interest rates another 25bps to 4.25%.
This policy action was expected but what surprised the markets was the surveyed data among the voting members. The results were significantly changed as you can see on the adjacent graphic where inflation expectations have shifted to a more hawkish view. So, why lower interest rates if that is their concern?
The Fed’s Inflation Forecast
The markets are now recalibrating to the shift in the Fed’s expectations as they got it wrong for this meeting. How much did it change?
The chart on the right demonstrates the higher expectation of inflation as measured by the PCE (Personal Consumption Expenditures) which is the Fed’s preferred inflation gauge. Despite the shift higher for 2025, they end up in the same place by 2027. However, this is a moving target and nobody expects their crystal ball has clarity beyond 6-12 months. This introduces a new grey area of what to expect from the Fed.
The Fed is telling us that inflation has not been conquered and the battle will continue. Consensus is now for two more 25bps cuts in 2025 but this could change if inflation persists. The graphic below demonstrates how forward expectations changed on Wednesday and shifted higher in a matter of hours.
There is also the growth side of the Fed’s mandate to consider as a slowdown in the economy may warrant lower interest rates. However, Q3 GDP clocked in at 3.1% Thursday morning evidencing a strong economy. This is likely a contributing factor for being hawkish as the Fed raised their 2025 GDP forecast from 2.0% to 2.5%. It is hard to get prices lower without a slowdown in growth so the Fed will be facing that challenge next year.
The Trend Break on the S&P 500 Chart
Below is a chart of the S&P 500 and you can see the decisive break of the lower white trend line on Wednesday which warns this may only be the beginning of a larger decline. We did get a snap higher to re-test the underside of this trend line on Friday. If the S&P can’t recapture the trend channel then we will work lower in the coming weeks. By the way, bounces happen when the Relative Strength Index (RSI) at the bottom of this chart gets to an oversold condition. However, momentum is still to the downside as shown by the MACD (mac-dee) so we are not in the clear just yet.
One more chart to review is the one below from Elliott Wave International that shows there are more stocks declining than advancing by a widening margin. This evidences a weakening of the stock market which is likely being held up by a handful of large technology companies (not ideal).
So, what happens next will be important for the tone of the market in the coming months. If we continue lower than we likely have a double-digit decline on-tap for the equity market.
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Paul J McCarthy III CFA
President, Kisco Capital
