Stocks plunged on indications that the Fed would slow further rate cuts after announcing a 25-basis-point cut at the FOMC press conference on Wednesday.
Really? That could be seen coming for months. The economy has proven resilient, unemployment is low, and retail sales are growing. The obvious question is: “Why cut rates at all?”
FOMC Decision
As expected, Chairman Jerome Powell announced a 25-basis-point rate cut, lowering the fed funds rate target to 4.25% to 4.5%.
Financial markets were spooked by the sharp jump in FOMC projections for rate cuts next year. The Dot Plot now centers on a further 50 basis points of rate cuts in 2025, a target range of 3.75% to 4.0%.
Compare that to the September projection below, which was equally divided between 100 and 125 basis points of cuts next year, a range of 3.0% to 3.5%.
Powell explained that:
- The economy is “strong” and has made good progress towards the Fed’s goals.
- The job market has cooled but remains “solid.”
- Inflation continues to move towards the Fed’s 2% target.
The Fed Chair provided further background in answers to reporters’ questions:
- “We feel that slowing the pace of future adjustments seems prudent now, especially as we expect inflation to be stickier than we initially thought.”
- “Some FOMC members did cite future inflationary fiscal policy as a concern.”
- “Most forecasters keep calling for a slowdown in economic growth, but we haven’t seen it yet and don’t see one happening soon. The US economy is doing great.”
- “We’re not too worried (about loose financial conditions). Both inflation and labor have cooled, so our policy is working. Financial conditions aren’t impeding us.”
Fed Balance Sheet
Powell announced that QT would continue at the same rate, but the rate offered on reverse repo (RRP) would be lowered, which may encourage further money market outflows into the T-Bill market. Total Fed holdings of Treasuries and mortgage-backed securities (MBS) have fallen by $1.9 trillion since their peak of $8.5 trillion in 2022.
Only another $6.0 trillion to go. 😟
Treasury Markets
Ten-year Treasury yields jumped. Breakout above resistance at 4.5% would offer a target of 5.0%, which would be bearish for stocks and precious metals.
Stocks
The S&P 500 plunged to support at 5860. Breach would signal a test of 5700.
Tesla (TSLA) dipped sharply after a spectacular two months, peaking at +117%, compared to Nvidia (NVDA) at -6.6%.
The weekly chart of the equal-weighted S&P 500 index ($IQX) shows a breach of support at 7150, likely headed for a test of 6900. The lower Trend Index peak identifies selling pressure but is still above zero, indicating that the primary trend remains intact.
Financial Markets
The Chicago Fed National Financial Conditions Index dipped to -0.66% on December 13, indicating “loose” monetary conditions. Moody’s Baa corporate bond spreads are also at a thirty-year low, reflecting easy credit conditions.
Bitcoin retraced to test support at $100K, but the strong uptrend still signals abundant financial market liquidity.
Dollar & Gold
The Dollar has strengthened in response to rising Treasury yields, with the Dollar Index breaking resistance at 108.
The Bank of Japan may be forced to raise interest rates again to support the Yen, which could cause an outflow from US financial markets as carry trades unwind.
Gold broke support at $2,625 per ounce, signaling a test of primary support at $2,550.
The long-term uptrend, shown on the weekly chart below, remains intact.
Silver similarly broke support at $30 per ounce, but a breach of primary support at $26.50 remains unlikely.
Conclusion
The Fed is riding a wave of deflationary pressure from the global economy, led by China. The bear market in crude oil and copper signals that global demand is contracting. Low inflation should enable further rate cuts next year, but the pace will likely slow as the Fed is wary of a resurgence in domestic demand.
The prospect of inflationary economic policies from the new administration could set off a public feud between Donald Trump and the Fed chairman. Stimulating an economy that is already close to full employment would force the Fed to hike rates to ease inflationary pressures, attracting the ire of the new president.
US financial markets, with rising long-term Treasury yields, are sucking up global liquidity and more than offsetting Fed tightening (QT). The strong Dollar increases pressure on international borrowers in the Eurodollar market as domestic exchange rates weaken. The Bank of Japan may also be forced to hike interest rates again to support the Yen, causing further unwinding of the carry trade and outflows from US financial markets.
The S&P 500 is overdue for a correction, but the primary uptrend is unlikely to reverse unless there is a sharp contraction in financial market liquidity.
Gold and silver are undergoing a sharp correction, but the primary uptrend remains intact. Two long-term fundamental trends support precious metals. First, central banks are increasing their gold reserves and reducing currency reserves as the global sovereign debt bubble expands. Second, in response to a collapsing domestic real estate market, Chinese investors are switching focus to gold and silver as a store of wealth.
Acknowledgments
- Federal Reserve: FOMC statement
- Federal Open Market Committee (FOMC): Summary of Projections
- Adam Taggart’s Thoughtful Money®: Reaction To Today’s Federal Reserve Rate Cut Decision
