Markets sold off on Wednesday as Federal Reserve Chair Jerome Powell explained why the central bank is expecting to cut interest rates at a slower pace than it had previously expected.
Investment strategists said that a hawkish shift by the Fed from a clear easing bias to one with more uncertainty over when and if rates will be lowered again in 2025 likely drove the negative sentiment.
Piper Sandler chief investment strategist Michael Kantrowitz told Yahoo Finance the Fed's "hawkish tone" was an "extrapolation" of recent moves in the market. Since the start of December, few stocks had been contributing to the S&P 500's ( ^GSPC ) gains as markets had begun pricing in the prospects of higher interest rates and sticky inflation for most of December.
"I kind of think of this as a bit of a reset from, certainly, where expectations have been over the last couple of quarters," he said. "I would almost describe this as a bit of a light pivot from Powell."
With investors growing increasingly bullish on stocks since Donald Trump's election win, the "light pivot" from Powell, who highlighted many of the prevailing market fears of the past month surrounding higher rates and sticky inflation, was enough to jolt a reality check into a market that's been steadily rising throughout 2024.
"The hawkish turn, plus the fact that we're starting to get more dissent [among officials] now, that uncertainty doesn't really bode well, especially when you're heading into a year where there's just this dramatic policy uncertainty around inflation, but also the labor market," Charles Schwab senior investment strategist Kevin Gordon told Yahoo Finance.
He added that "you have really euphoric, sometimes somewhat exuberant sentiment, and then a negative catalyst comes along to tip the market over. And that's exactly what the Fed meeting was."
But largely, bullish investors don't think Wednesday's Fed meeting was a complete narrative shifter for market in the coming year. Gordon pointed to Powell's positive outlook for US economy as a "healthy backdrop" for stocks even if 2025 doesn't bring as many interest rate cuts as investors would have liked. Markets appeared to show signs of this sentiment on Thursday as stocks attempted to stage a rebound from Wednesday's brutal sell-off.
"Equity markets were clearly disappointed by Powell’s comments, but nothing he said fundamentally alters the bull case going into next year," DataTrek Research co-founder Nicholas Colas wrote in a note to clients on Wednesday night. "In the end, we may see fewer (or even no) rate cuts, but that’s because the US economy continues to grow and create marginal inflation as a byproduct."
While it may not have shaken the bull case for stocks in 2025, Wednesday's market action did serve as a teaser for what strategists believe could be a more volatile investing environment in 2025.
The Fed's Summary of Economic Projections (SEP) laid out a clear case for why the central bank would project just two rate cuts for 2025 versus the four it forecast in September. Officials marked up their projections for core inflation and economic growth next year while lowering their forecast for the unemployment rate in 2025.
But when describing the Fed's thinking, Powell did little to calm investor fears about the unknowns headed into 2025.
He used some version of the word "uncertain" the greatest number of times seen in a Fed press conference in 2024. He said there was higher uncertainty about inflation. He didn't outright decline the possibility of an interest rate hike next year. And he even admitted that some officials have started accounting for "policy uncertainty" from the Trump administration in their forecasts.
Given the unclear nature of those polices , this only further muddles the outlook and provides further support for the Fed's caution cutting rates in 2025.
"It's kind of common-sense thinking that when the path is uncertain, you go a little bit slower," Powell said. "It's not unlike driving on a foggy night or walking into a dark room full of furniture. You just slow down."
At large, this points to further data dependency from the Fed in 2025, Gordon said.
"There is a degree of just more elevated uncertainty and maybe trepidation because the Fed is going to have to be in this reactive position," Gordon said. "It's not like they've gotten out of data dependence mode, but I think it puts them back into a hyper data dependence mode where every single jobs report and every single inflation report now is going to be scrutinized."
Josh Schafer is a reporter for Yahoo Finance. Follow him on X @_joshschafer .
