The Federal Reserve surprised Wall Street on Wednesday, signaling that just one quarter-point rate cut is likely this year. The hawkish shift from Fed Chair Jerome Powell was surprising after the May consumer price index delivered the best inflation news all year. But the S&P 500 and Nasdaq, which rallied to fresh record highs on the tame CPI data, still managed solid gains.
Fed Rate-Cut Outlook
New quarterly projections showed the Fed's benchmark interest rate falling to 5.1% this year, implying 25 basis points in rate cuts.
As of March, policymakers were still leaning toward 75 basis points in rate cuts, which would lower the Federal funds rate to 4.6%.
The projections reflect the median among forecasts offered by 19 Fed policy committee members. Eleven policymakers see no more than one rate cut as appropriate, including four who penciled in zero cuts, while eight see two rate cuts as warranted.
For 2025, Fed policymakers see a year-end rate of 4.1%, implying four additional quarter-point cuts. In March, projections showed the Fed's key policy rate falling to 3.9%.
CPI Outweighs Hawkish Fed
Wall Street took the Fed guidance in stride, with the hawkish surprise merely toning down the celebratory mood after the CPI surprise.
May's 0.16% rise in the core CPI, the smallest monthly increase since August 2021, could signal the renewal of a disinflationary trend. Powell made it clear that one inflation report isn't nearly enough to give the Fed the confidence it needs to start cutting rates.
Still, Powell said that more good news like today's CPI would lead the Fed to lower its inflation forecast. That's important, because the rate-cut outlook is closely linked to progress on inflation.
"The big thing that changed was the inflation forecast," Powell said, in explaining the change to just one rate cut. He added that this was more a timing change for Fed rate cuts than a change in the ultimate destination, with one extra rate cut moving to 2025.
Powell added that the Fed rate-cut projections aren't a plan and will shift if the data comes in differently than forecast.
Fed Rate-Cut Odds
The CPI had a bigger impact on markets than the Fed's forecast of a single rate cut this year.
Odds of a quarter-point rate cut on Sept. 18 jumped from around 50% before the CPI to 73%, then eased back to 62% after the Fed policy update and Chair Powell's news conference.
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Powell's 'Consequential' Concern
Powell has previously indicated that the timing of the first rate cut of the cycle matters more than subsequent cuts. On Wednesday, he explained why.
"When we do start to loosen policy, that will show up in a significant loosening in financial market conditions," Powell said. "It's a consequential decision for the economy and you want to get it right."
That could be read in a few ways. It could mean that a rate cut will stimulate business investments and borrowing that are on hold until the Fed acts, giving the economy new momentum.
However, Powell also may be thinking about the impact on the S&P 500. Stock prices are a major contributor to financial conditions and have been the major reasons why current financial conditions have been easier than they were when the Fed started hiking in March 2022.
Market strategist Ed Yardeni is among those who have said that Fed rate cuts could lead to a melt-up of the AI-led stock rally. That would be reminiscent of the 1990s stock boom that led the Fed to overtighten to slow the economy amid asset-price inflation.
S&P 500
The S&P 500 rose 1% and Nasdaq 1.65% in Wednesday stock market action, both finishing at new record closing highs. On Tuesday, the S&P 500 rose 0.3% to record its 27th record closing high this year.
The 10-year Treasury yield fell 11 basis points to 4.295%.
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